treasury mngt

7/29/2019 Treasury Mngt

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Introduction

The role of Treasury Manager has changed dramatically during the lastdecade. From a narrow facilitator of transactions, with few analytical tools,the task of treasury management has become a dynamic, quantitativefunction, providing service and often-additional profits to the entirecorporation. The financial arm, today, is often the lifeblood of a corporation.Today the strength of treasury operations is often what distinguishes alackluster performance from stellar growth in quantity in quality of earnings.We have explored the traditional function in detail, with particular reference

points; we will be able to see how treasury management has changed. Theforces behind these changes will be explained and assessed for importance.We will also review some of the important new tools used by TreasuryManagers to achieve the broader, more difficult tasks required in themodern, global business climate. Some case studies will illustrate Treasuryoperation in practice. Lastly, we will conclude with some sensible guidelinesfor the task of Treasury Management.


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Traditional Functions of Treasury

Manager

To say that financial management is critical to all businesses is an obvioustruism. But to observe that the task of financial management has changeddramatically in recent years is less obvious. In terms of product andtechnology many industries evolve slowly. Although Financial Managementas a field has been studied separately since the turn of the century, earlyemphasis was upon the legal aspects of such matters as mergers, formationof new companies, and type of securities. With primitive capital markets, themain task facing the corporate treasurers was securing funds for expansion.Earnings and assets values as reported in the accounting statements were

often unreliable. With insider trading and manipulation, stock pricesfluctuated widely. The average person had neither the means nor acumen for

playing bond and stock markets. As a result of these conditions, some ofwhich played a role in the great crash of 1929, the purpose of the financialmangers was as largely a legal function. Even after the reform of 1930s,finance was still taught not until the 1950s, using rigorous mathematicalmethods that such issues as:

The purpose of financial markets and innovation;

The optimal mix of securities;

How securities are priced; and

How investors make investment decisions

Were addressed. Both the assets and liability sides of the balancesheetbecame much more interesting, especially form the standpoint of how theyare related.

New tools for analysis were created. Most importantly, the above intellectualachievements led to a general theory of finance, which finance managersutilize for both day-to-day as well as the long-term challenges facing thefirm. We will review these achievements below. After which we willexamine some of these traditional functions of financial managers,

beginning with general responsibilities and thereafter turn to specificapplications.


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Intellectual Achievements

During the 1950s and 1960s, the science of finance, from humble

beginnings, grew into widely accepted and used general theory addressingthe issues mentioned above. Although research since then has enhanced andrefined these achievements, it is arguable that the foundations achieved willrest secure for a long time to come. Without attempting an exhaustiveliterature review, from the standpoint of Treasury Management, it is usefulto take note of this intellectual heritage and the key concept, which itcreated.

Net Present Value

Investments involve the exchange of know amounts of cash today forexpected returns in the future. Given what we have in hand, thefundamental question is always how much is the future worth. Whenwe calculate Net Present Value, we are determining whether theinvestment or project is worth more than it costs. All Treasuries utilizethis basic but critical method of analysis. Using the relevant cost ofcapital, managers will discount future cash flow to determine their

present worth. The methodology underlying NPV, permits millions ofshareholders of vastly different backgrounds and expectations, to

participate in the same enterprise through bonds and shares, with one

view in mind: maximize the Net Present Value of my investment.

Capital Asset Pricing Model

The CAPM is centerpiece of modern financial theory, because it givesTreasury Managers and other financial professionals a meaningful andmanageable way of thinking about the required return on the riskyinvestment. Or, how one trade off risk and return. The model is attractive

because it specifies two kind of risk those, which one can diversify away andthose which one cannot, - market risk. Market risk measure by beta, which isa measure of the extent to which a particular investment is affected by achange in the aggregate value of all assets in the economy. The mostimportant risks are those, which are not diversifiable, which is why, therequired return on an asset increase with its beta. The Model is a cornerstoneof the practice of Financial Management.


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Efficient Capital Markets

The third fundamental idea upon which modern financial theory is based isthat the prices of securities accurately reflect available information andrespond rapidly to new information as soon as it becomes available.Although expressible in different strong and weak versions, the idea merelysays that capital markets are very competitive. Of course, some people willuse available information better than others. The point, however is that thereare no easy ways to make money in such marketsprices generally reflecttrue values.

Value Additivity

The fourth principal of modern finance is that the whole is equal to the sums

of the parts. This rule applies to investments and the corporate structure offirms. For example, if a petroleum company decides to diversify into the

prepared food business, an activity where there is no clear synergy such astransferable technology or decreasing average cost, the new company willnot be worth any more than its constituent parts. The principal of Additivityalso applies to capital structure, other things equal a firms capital structuredoes not affect the value of the firm: so long as the total cash flow generated

by the firm has not changed, its value is unchanged. With the same cashflow, value is independent of capital structure.

PROFITS ARE THE REWARD FORN TAKING RISK

X Rate of Return


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Y RiskHigher return comes with greater risk.

Option Theory

The final cornerstone of modern financial theory is theories on the pricingand behaviour of options. In finance, options refer to the right to buy and sella security or commodity in the future on terms, which have been fixedtoday. For a time in the future, an option with specific pricing, timing,delivery, quality provides the right to sell or purchase a security, acommodity, or foreign exchange. Options have long been part of the productrepertoire, although beyond looking at the forces of supply and demand, itwas not known how to evaluate them. Today, the use of option forms acritical ingredient in the risk managementfunctions of the modern Treasury

Manager.

General Responsibility

Using the above theories, the financial managers primary task is to plan forthe acquisition and uses of funds or capital so as to maximize the value ofthe firm, in this regard; general responsibilities include the four followingareas:(A) Forecasting and Planning - The financial manager must interact with

other executives as they make short and long term, strategic and tacticalplans for their firms future.

(B) Major Investment and Financing Decisions On the basis of long-runplans, the financial manager must raise the capital needed to support thefirms growth. The economic growth and technological change implythat competitors are always on the horizon; therefore growth in sales andrevenues is an on-going objective. This requires increased investment in

plant, equipment, and current assets necessary to produce goods andservices. The financial manger must help determine the optimal rate of

sales growth, and he or she must help decide on the specific investmentso be made as well as on types of funds to be used to finance theseinvestments. Decisions must be made on the mix of internally. Shouldsuch funds be in the form of debt or equity? Should debt be of a long-term or short-term nature?

(C) Interaction with Capital Control The financial manager mustinteract with executives in other parts of the business if the firm is to


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operate as efficiently as possible. All business decisions have financialimplications, and therefore all managers both financial and otherwisemust take this into account.

(D) Interaction with Capital Markets The financial manager must dealwith the money and capital markets. Seldom is it prudent or desirable touse only internally generated funds for growth, and to be alwaysmatched in assets and liabilities.

Form the above, we see that the general responsibilities of financialmanagers involve decisions such as which investments their firms shouldmake, how these projects should be financed, and how the firm can mosteffectively manage its existing resources. Success in these areas, using thenew tools of finance mentioned above, would lead to the maximization ofthe value of their firms in the interest of shareholders, as well as serve the

broader interests of those who work for the firm along with those who dealwith the firm.

Applications

In the remarks below we turn to some of the traditional activities in whichcorporate treasuries are involved. No firm is identical, and therefore theimportance given to these various activities may vary, but they are allimportant. We note that while some of the methodologies have changed, theapplications remain critical to any corporation. We will look at some of thefollowing traditional function of treasury management.

(A) Banking Relationships There are a myriad of ways in which themodern Treasury Manager uses and relies upon relationships with

banking and other financial institutes. Without describing the purpose indetail, in developing and maintaining good relationships with various

banks, the Treasury Manager is ensuring that the banks resources,technology, and expertise will be available to him whenever required. It

might involve access to trade finance or to facilitate sales to a customerin another country. It might involve a line of shot term credit to financereceivables. It involves the investment bank, which structures and placesthe new rights issue to raise equity capital for expansion. It might involvea dealing room of the bank through which commodity options may be

purchased to manage the value of a running inventory. Banks clearcheques, operate lockbox plans, supply credit information, etc. the


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possibilities are as varied as the nature of business. Developing andmaintaining relationships with financial institutions, especially onewhose strength is critically related to a firms needs, is a goods business

practice.

(B) Cash Management How much of a firms assets should it hold in casha Non Performing Asset is an ever present question facing themanagement of both the smallest partnership and the largest transnationalcorporation. Statistical surveys reveal wide difference in the percentageof assets held in cash or fullyliquid securities. Synchronization ofdisbursement and receipt reduce the need to maintain idle assets such ascash, although having a positive float the difference between a firmscheckbook balances and the balance shown on a banks books, may beused advantageously. The Treasury Manager in deciding how much of a

firms assets to hold in cash must look at some of the following reasonsfor holding cash:

Transactions Cash balances are necessary in day-to-day businessoperations. Routine payments and collections required that a portion ofassets be kept in cash.

Precautionary Balances The less predictable the forms cash flows,the larger such cash balances should be, although the firm has goodaccess to borrowed funds, its need to hold cash will be smaller. A

purchase of replacement inventory after an industrial accident, or havingfunds on hand to make a legal settlement; are all examples.

Speculative Balances- some cash balances may be held to takeadvantages of any bargain purchases that might arise. For example,

buying up inventory from a distressed or bankrupt seller.


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Long -term financing - Although an important role a treasury manager is todevelop banking relationships, the financing of specific projects iscritical task. In general, it is desirable to connect a particular project forexample, a new plant or new division or new product to a particulartranche of financing capital. Using a general pool of funds approachfor various project doesnt relate the cost of funds to the project,therefore renders it difficult to measure the return on borrowed capital.Traditional long-term debt interments as used by Treasury Managers,may be in the form of a Term Loan, which is contract in which a

borrower agrees to make a series of interest and principal payment onspecific date to the lender. Unlike raising equity capital for anexpansion, term loan are quicker to obtain, and usually more flexible.Finance may also be raised by issuance of bound, which are promissorynote backed by the credit worthiness of the firm. Deciding which type

of financing is best and how to structure it is the role of TreasuryManagement. The Treasury Manager must look at interest rates bothnow and into the future, along with the affect of borrowing upon thefirms capital structure and condition. Always, the question is themarginal impact upon the overall position of a discrete decision, suchas how to finance a new product line or expansion.

(D) Credit Management Although one hears much of corporations beinglean &mean & cutting cost to the bone, ultimately the generation ofrevenues come first. Unless a firm products are in demand, unless sales arehealthy profits will not be generated. To maintain & grow sales, although

pricing quality, advertising are important, credit policy is offer a criticalfactor. In fact, at times it may be an excellent source of revenues in itself, &actually enhance sales. Our willingness, on average, to enter into hire

purchase agreement rather than paying cash is an obvious example of howthe provision of credit may actually enhance sales. In developing credit

policies, Treasury Managers must evaluate and following consideration withrespect to their client base:

Credit Period:Hoe long to buyer has until they must pay for their purchases?

Discounts:

Are their discounts to encourage early payment? Will it attract newcustomers? Will it reduce the collection period /


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Credit standards:

What are the financial requirements of a customer in order to qualify forthe credit? A national credit rating agency might be utilized: The fiveCs must be utilize: Character, Capacity to pay, Capital showing debt to

assets ratio, collateral, and Conditions of the general business climate.

Collection Policy:

How does a firm follow-up on show paying account? Remember collectionagencies and attorney is an expensive option.

(E) Dividend Policies An ongoing study at Harvard Business Schoolrecently reported that the present capitalization of many major firms is

purely result of their investment over the last decade or so. Assets from theearly 1980s would today have a negative economic value. On the capital,which was invested, on average the return was below the market index. Inother words, the shareholders of many blue chip corporations, would have

been better off, if all earnings had been aid as dividends, rather than beingquestion is what should have been done to maximize the value ofshareholder investment?

Observations such as the above have led to a great volume of research onoptimal dividend policy. According to the Value Additivity Principalsobserved above, A firms dividend policy should have no bearing upon itscapitalization in the securities market, because an investor should not value adollar of dividends more than a dollar of capital gain, apart from taxconsiderations. This argument is known as the Dividends IrrelevanceTheory, According to which the value of the firm is determined only by its

basic earnings power and its business risk. Income Produced by assets, nothow the income is split in what matters.

An alternative view is that the cost of capital increases when a firmsdividend payout is reduced. Known as the BirdIn-hand theory, thisapproach to dividends more highly than expected capital gains, because thelatter is less likely. So, therefore, the mix between dividends and capital gainachieved through retained earning does matter. Which is right? Empiricalresearch has not yet settled the issue, but Treasury Managers must take into


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account both perspectives, especially if they see their shareholders asmaking similar types of investments with disbursed earning, i.e. dividendsAre investors going to use dividends to buyinto capital gains from otherfirms?

Other considerations, which Treasury Management must take into account indeciding on dividend policies, are such factors as Signaling and ClientSegmentation. Changes in dividend policies are often regarded by the stockmarket as indicative of a firms overall health. Increasing earnings might saythat the firm is doing well, although it might also say that the firmsmanagement has nothing else on the agenda to do with the retained earnings.Client segmentation refers to perception by the investing public of the firm.Is the firm a high risk, small capitalization growth stock with good ideas forfurther investment with retained earnings? ; Or it is stable, blue chip concern

of which investors expect a consistent modest return? The formal type ofconcern seldom pays larger dividends if at all; by the latter invariably paysreliable returns. Investors in the highrisk concern are therefore the potentialof capital gain; while investors in the stable blue chip concern are lookingfor regular income. In deciding upon dividend policies, TreasuryManagement must take into account that their shareholders are and whatthey are expecting.

(F) Insurance Few of us are not at one time insured something, be it amotorcar, a house, or the commercial assets of the business. Insurance maycover all manners ofbusiness risk, including the health of key executives,industrial accident, industrial unrest, physical losses, business interruption,to mention only a few. Although an exhaustive review of the insurance fieldis beyond the scope of this discussion; it is important to note that manyTreasury Managers have recognized that the topic should not be consideredin isolation. Insuring against the loss in revenue from fire at a factory maynot be that different from the loss in revenue if there is severe decline inmarket share or even a dramatic falls in the prices. As the theory ofinsurance is that the transfer of risk to firms betters able to manage it

represent a gain in general, perhaps there are times when such risk should beborn internally, i.e. self-insure. Thus comparing historically, premiumpayments with refunds can be very useful guide the net benefit of insurance.A good Treasury Manager thinks comprehensively.

(G) Pension Management A pension fund is a pool of funds establishedby an organization to pay the pension benefits of retried workers. Annually


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pension invests in securities markets. Generally, the earning on pensionfunds are tax deferred, that is the retired worker only pays taxes upon theearnings when the benefits are received upon retirement, when presumablyhe or she faces a lower marginal tax rate. The management of such funds isone of the main traditional roles for the management of treasury department.Although, like insurance, the management of pension funds is thespecialized field in which the advice of outside experts is often useful, it isgenerally the role of Treasury Management to set the objectives andcoverage for the fund and monitor its performance.

The Age of Uncertainty

As mentioned earlier the new role of Treasury Manager has come about inresponse to the changing economic and financial environment. If there is oneword to describe how business is today versus half-a-century ago, the wordwould be risky. Measured by the range of possible outcomes in any businessscenario, measured by how rapidly various trend fluctuates, measured by

variance in key operating parameters, measured by the pace of technologicalchange; the world is clearly a riskier place than it was at the end of theSecond World War.

Financial Innovation and Risk

In the early 1970s, the Chicago Mercantile Exchange introduced the firstsuccessful exchange-traded currency futures. It was widely argued that such

products as futures and options were introduced and become popular as amean to manage the new risk found in the business environment. Known as

Derivatives, they are derived from underlying markets, such as commoditiesor foreign exchange, which had now become unstable and volatile. In 1975,interest rate future contracts followed, which allowed one to established thefuture cost of lending and borrowing. By 1982, half-a-dozen exchanges hadintroduced various interest rate futures contacts, covering very short tolonger-term borrowings.


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The next step in global derivative development for managing and controllingrisk was the introduction by the Philadelphia Stock Exchange in 1983 ofcurrency options. Currency options linked the futures and options which hadrisen in the capital markets of key hard-currency countries, currency optionsand futures would lead to the development of many further risk managementtechniques. Without the tool of managing exchange rate movements, globaltrade and investment can be very risky. The Treasury now had an array oftools to manage the risks faced by modern, global corporations. Without theuse of derivative products by proactive treasury managers, many of the

benefits, which we enjoy today from globalization, would not be possible.

By the mid-19870s, a revolution in financial, foreign exchange, andcommodity risk management had taken place through the use of futures,options, swaps and Forward Rate Agreements (FRAS), which are series of

consecutive forward or futures agreements. Such product enabled treasurersto price and transfer risk in a global manner. On the Chicago exchange, forexample, the trading volumes involved tens of million of contacts annually.Derivative exchanges were introduced in New York in 1980, in London in1982; in Singapore Monetary Exchange in 1983 saw financial futures wereintroduced Frances Matif. To meet the needs of management of controllingrisk, the development of new derivative markets continues, with newcontracts appearing regularly. On over fifty exchanges around the worldsome from of derivative instrument is today traded.

From the above we see that these markets have not arisen in isolation but inresponse to the global integration of trade and finance. By being global inscope, such markets have created a mechanism for pricing and transferringrisk around the world. These markets allow financial officers and treasurersto manage risk efficiently. Today treasurers of corporations, banks, and

public entities have no excuse for not managing unexpected surges ininterest expenses, swings in exchange rates, or increased commodity pricesaffecting raw material cost.

Innovation and Risk - Recent trendsAn important features of the growth in the use of derivatives markets, likefutures and options, has been the evolution and maturing of Over-theCounter (OTC) market. While traded futures and option are suitable for theday-to-day risks by most Treasury Management, often there are situationswhere only a custom-made solution will satisfy specific commercial andfinancial objectives. A new investment or an innovative financial structure


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may have an unusual risk/reward profile. The financial engineers are usingoff the shelf futures and options products available on the major exchangescan devise one-off product to satisfy such needs. Often hybrid derivativeshave been devised to address the combined risks involving several markets.It might be the ratio of gold to silver prices or an equity-linked bond. Toaddress these exposures, Treasurer working with the financial engineermight use derivatives in combination, mixing futures and options, currenciesand commodities and different maturities; all to achieve a particularobjective.

Post-Industrialism and the Service EconomyA quarter century or so ago, the service sector played a much smaller role,and information technology did not exits. The energy, communications, andtransportation sectors operated under a rigorous regulatory framework.Similarly, the role of unionized labour was much greater than today, and ofthat portion, public sector employees played a small role. Mass discountretailing and micro marketing did not exist. Inventory was managed on aquarterly basis, or less frequently. The percentage of debt in corporate

balancesheet was proportionately lower. Globalization of product, tastes, andsuppliers was not yet imagined. Capital, labour, and technology were tied tothe domestic economy. Broadly defined goods and services, which aretaken, for granted today did not exist or were only the province of the rich.

How times have changed. It I difficult to think of a place anywhere in theworld not effected by the dramatic changes of the last quarter century. By allthe measures mentioned above and countless others, the world economy hastransformed itself beyond recognition, and by and large it was the result ofendogenous, organic factors. How and why these changes have occurred is asubject of ongoing research, but certainly it was not the result of the state

intervention, no matter how much various government have attempted topromote, facilitate or retard such processes.

Today, the buyer for a major retailing firm such as Benneton or the Gap, cantake notice of a fashion trend, and in less than a month have it designed,manufactured, market and stocked in the outlets throughout the world.Today, software engineers situated in distant parts of the globe hold virtual


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meetings to discuss the production of software code. Today, investorlooking for an attractive bond can browse the Internet searching for thehighest yield. Consumer loyalty to goods and services lasts as long as thenext product launch. Watching the exchange rate trends, corporate managerallocates production to plants throughout the world. Gone are the days of

blanket advertising: today, modern data mining and data surveyingtechniques allow a corporation to target its customer with pinpoint accuracy.With knowledge of regional demographic, national chain stores are able toadjust the goods they feature to satisfy local taste. From head office, thehead of marketing for a major petroleum company can adjust prices to thetime of day, in a thousand service stations, by merely sending through codecomputer instructions. Just-in-time deliveries of raw materials and parts tothe factory gate ensure smooth production without money tied up ininventory. Out-sourcing of required goods and services, for which a firm has

no comparative advantage in producing, allows management to focus uponcore activities.

The ways in which the global economy has changed in the last quartercentury are virtually limitless. The above anecdotal observations are onlyhere to remind us that given these dramatic trends, to imagine that the job ofTreasury Management should be unchanged would be foolish. Higher levelsof technology imply higher rates of returns, however the Cost is that theworld has become a riskier place. Proactively and dynamically, TreasuryManagement must define their responsibilities as broadly as possible, takinginto consideration the new upsides as well as the new downsides, whichhave become possible. In the next section, we will describe differentmodels for Treasury Management for dealing with the new world in whichwe operate.


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Changing Responsibilities

The 1970s saw Treasury Management attention diverted to such pressingproblems as:

Inflation and its affect upon accounting;

Deregulation of financial institutions into broad service corporations;

Dramatic innovations in the use of computers for analysis andtelecommunications for receipt and transmission of information;

New and innovative methods for financing long term investment; and

Unprecedented volatility in the economic environment.

It was not that the financial mangers primary task of planning for theacquisition and uses of funds or capital so as to maximize the value of thefirm and facilitating transactions had changed. Rather, the task of doing this

in a world of floating exchange rates, globally competitive labour forces,rapid technological change, etc., had become significantly more difficult. Inthe remarks below, we will present new approaches or models of TreasuryManagement.

Traditional Treasury as a cost centre


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Treasury as a facilitator of transaction flow of business units

Treasury with a process orientation towards risk.

Treasury with a reactive strategy towards business development.

Modern treasury mangers ready to meet the challenges of the post-industrialinformation age, may be modeled as either service centre, or even as a profitcentre. Defined functionally, the two approaches would include thefollowing responsibilities:

The Service Centre Treasury

New trading orientation

Development of innovative risks management techniques.

The application of such techniques to business units.

Minimization of overall financial risk.

The Profit Centre Treasury

It has its own Profit and Loss account

It undertakes exposures with no specific match with the natural exposureof the firm

Gains and losses are used to offset underlying exposures at aconsolidated level.

Which one is better? Which approach is correct? Well, it all depends.Certainly the service centre model of modern Treasury management is themore prudent of the two approaches. It addresses the needs of thecorporation from the standpoint of the challenging and dynamic world inwhich the modern, global corporation operates. The profit centre modeldoes that as well, but the taking on new exposures which may or may notdirectly offset losses, or enhance gains of operational profit centres. The


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profit model transforms the cost or service centre approach into a dynamicunit, which may contribute to the quality and quantity of earnings.

The risks of the profit centre model however are significant. Performedcorrectly, it can add greatly to bottom line, badly, however, the results may

be disastrous. General Electric is arguably one of the worlds mostsuccessful corporations. With a product base not dissimilar to GermanysSeimens Corporation, GE earns twice the rate of return on equity. How doesit do it? According to some experts the secret is in the management of GECapital Corporation, which not only facilitates and enhances the sale ofeverything from refrigerators to industrial turbines, but also operates as a

profit centre, with dealing and trading operation, which rivals any majorcommercial bank. When Treasury Management without any specific matchundertakes exposures to underlying activity, purely for profit, things may go

wrong. The spectacular losses by certain American, British, and GermanCorporations in the use of derivative exposure are notable examples.Creating additional risks for the possibility of profit when core businessactivities in which the firm is supposed to have an advantage are ignored ornot properly facilitated is hard to justify. In deciding which approach to theManagement of Treasury is favoured, the firm should evaluate its strength,and if those are not equal to those of GE Capital, probably the service modelshould be favored.

Strategic and Tactical Planning

Although corporations and firms have always planned for the future, thetreatment of the Planning function as a separate entity usually falling underthe Management of Treasury is a relatively new business innovation. Likethe development of the service centre approach to treasury or the use ofderivatives, the planning function has grown in importance because of thedynamic environment in which we live. Problems and issues neverimagined several decades ago, are today the stuff of management meetings.

Today still, many corporations neglect planing because the process requiresthinking about the future, and the future is always uncertain. Although a fulldiscussion of the topic of planning and management is beyond the scope ofthis workbook, some thoughts and guidelines may be mentioned.

The planning function is part and parcel of Treasury and Financialmanagement. A capital budget cannot be conceived, a source of funding


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identified, a risk management strategy developed without having a view ofthe future. Planning for the future starts with an intimate and realisticunderstanding of existing products, divisions, markets, profits, returns oninvestment, cash flow, availability of capital, research and developmentabilities, and the skills and capacities of personnel. How is the organization

performing today? From understanding the present, we constructpredictions of the future. There are many different, equally valid methods offorecasting the future. The Management of Treasury must evaluate forecasts

prepared by divisions for reasonableness. Are they consistent with oneanother? In taking the lead on this important task, Treasury Managementshould consider the following guidelines for planning.

GUIDELINES FOR TREASURY MANAGEMENT OF PLANNING

1. Create an awareness of the need at Division level of the need forplanning.

2. Assess how well the divisions have integrated the plans into their

programs. Are they consistent?

3. Create a means of implementing continued planning so that thedivisions will complete any unfinished plan or revisions during thecoming financial year.

4. Determine what standards for measurement, if any, the divisions havein setting goals.

5. Determine if the plans are consistent with capital budgets and

technological resources.

6. Promote the idea that Divisions should consider a wide range ofpossible projects. The ranking can come later.

7. Assess the reasonableness of goals, so as to devise a long-termscorporate goal.


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8. Determine whether the resources, capital, manpower, and technologyare available or can be made available to implement the selected plan.

9. Establish a programme for monitoring the Plans implementation; itmust not be filed away.

10. Look for synergies between divisions in constructing andimplementing the plan.

FORMULATION OF CORPORATE

TREASURY POLICY

What a corporate treasury policy can do for you...

It can: Define the strategy on foreign exchange and interest risk - and it

communicates this strategy to regulators, shareholders and employees.

Set a framework for the control and management of exchange rate andinterest rate exposure.

Set objectives and performance criteria for corporate treasury personnel.

Who should be involved in drafting such a policy?

Foreign exchange and interest rate risk may constitute a significant elementof a company's total business risk.If this is the case, senior operational executives must frame corporatetreasury policy. This is necessary to ensure:

The mandate from shareholders is fully understood.


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The thrust of the policy is consistent with the business culture andorientation of the organisation.

Senior management fully understands and appreciates the parameters of sucha policy. The policy gets full credibility in the eyes of employees and other

stakeholders.An ideal team for drafting corporate treasury policy should include:

The corporate treasurer

A tax specialist

The financial accountant

The sales and purchasing executives

The chief executive officer.

When the policy is complete

The policy should be presented to the Board of Directors as a framework forthe management of the organisation' s financial risk.The financial risk of the firm is dynamic and ever- changing. The TreasuryRisk Management Policy needs to be reviewed regularly to ensure that itreflects these changing circumstances. The policy should be formallyreviewed every year. It should be subject to ongoing evaluation through thecourse of the year.The formulation of a policy is the first step in defining a financial riskmanagement culture for the organisation. The next challenge is tocommunicate this policy clearly to all interested members of theorganisation - and maybe even outside stakeholders. This can be ademanding but vital exercise. Without the full understanding and support ofall the business units, the Risk Management Policy may be less than fullyeffective.

Policy formulation questions and answers

The formulation of a Risk Management Policy will raise many key issues forthe firm. Remember that the Risk Management Policy will be unique to theorganisation. There are no generic policies or limits.


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In the sections that follow address many of the key questions, which one willneed to consider. And put forwards some suggestions and recommendations,which one will find helpful. These are statements of risk management

principles and guidelines which one will need to translate and interpret forhis/her unique business circumstances.

SHOULD THE FIRM HAVE A CENTRALISED TREASURY

FUNCTION?

This is usually an issue only for large, diversified corporations. The decisionon whether or not to have such a function can be influenced as much by theculture of the firm as by business rationale.The principle criticism of a centralised treasury function is that it devolvesfinancial responsibility away from local managers. This dilutes their sense of

responsibility and accountability and can lead to lesser motivation on theirpart.

The weight of argument in favour of centralisation is powerful. There arereal benefits, which include:

* Administration cost savings from centralised information,dealing and control systems.

* Greater efficiency in netting intra group exposures and theminimisation of third party dealing.

* More focused relationship with bankers and the potential formore competitive pricing due to larger volumes.

* Greater ability to exploit central treasury expertise as itbecomes easier to tailor training programmes, reward structuresand performance reviews for a distinctive staff grouping.

* Greater consistency in hedging practice and techniques.

A single source of contact with the market is also a good way to preserve

and enhance the company's financial status. Errant behavior by subsidiaries -which might damage the whole group - is avoided.

Others argue for a halfway house position. Some firms operate on the basisof central monitoring of positions. Others have structures, which allow thelocal manager the facility of hedging his or her risk with the central treasury.


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In this way, the central treasury maintains control but the local manager isstill fully responsible and accountable for financial performance.There is no single best solution. On balance, it would seem there is more to

be gained by a focused centralised approach. If such a strategy can bemodified to ensure greater accountability at local level, this could be the bestof both worlds.

YOUR TREASURY OPERATION - A PROFIT CENTRE OR NOT?

A key question for many firms is whether the Treasury operation should bea profit centre or not?The term "profit" centre may need to be defined. Some interpret this to meantrading in the financial markets; others see it more in the context of addingvalue for the firm. Let us review the merits and demerits of the profit centreapproach.

The argument for....

Advocates of a profit-led approach are in no doubt - it's the only way toensure that the Treasury division does the best possible job. After all, theyargue, if other business divisions must be profitable and add value tosurvive, why should a treasury function be a special case? How else can thesuccess of a Treasury function be measured, if not by its financialcontribution?

Such advocates suggest a profit objective is the only way to make operatingmanagers respect the Treasury function and for Treasury personnel to beseen as adding value to the organisation.Supporters of the profit imperative also say service and support is difficult toassess - some would add that it defies rigorous measurement. They feel thatif Treasury, or any other business division, was left without financial

performance criteria, it would be ill advised.

The argument against...

Supporters of a non-profit centre approach are convinced that a Treasury

department's main function is the reduction and control of risk. Profit-driventrading in financial markets is not part of their brief, they say, and not part ofthe business of the firm.In fact, if financial performance is the only yardstick, it can affect Treasury'sability - and desire - to help and support other business divisions in theorganisation. At the extreme, operating units may see the Treasury functionmore as a competitor than a service provider. This could lead to less trust


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and personnel may spend more time on internal profit appropriations ratherthan seeking to add value to the enterprise.The anti-profit centre lobby also argues that objectively and quantitativelymeasuring the financial performance of a Corporate Treasury function is farfrom an exact science. They say if an organisation puts a strong emphasis onrisk reduction and this is achieved in demanding circumstances, how can aquantitative financial value be put on this?

How can your firm take the right decision?

Both arguments are clear. So how does one make the right decision for hiscompany?Both the extreme pro and anti profit centre positions have their pitfalls.The view would be that the Treasury function should be profitoriented ............but;

- This should be one of a series of objectives for Treasury andone define profit as seeking to add financial value for the firm(not trading)

Striking the right balance between the financial value-added objective andother objectives is the next challenge.

Striking the balance - the three key factors

Recommendation is that a financial objective should be set, along with other

objectives. The emphasis placed on this financial objective will vary fromone firm to another. When deciding what is appropriate for the firm onemight consider each of the following three questions: -

What is the weight of financial risk as a proportion of the firm's totalrisk?

What is the gap between the firm's "natural" financial risk profile andtheir returns?

What is the expertise in financial risk management?

The greater the weight of the companys financial risks as a proportion oftotal risk, the greater the need to add value from that element of the business.If the culture of the firm is to retain a high proportion of "natural" financialrisk, the greater the demand for a return in this area.
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The more expertise a company has in making money out of the managementof financial risk, the more likely the desire to exploit these skills - and reap the appropriate rewards.In summary, the greater the significance of financial risk for the firm and thegreater is the need to transform a natural risk profile, the more appropriate it will be to place a heavy emphasis on adding financial value. Even then, this is advisable only if one has the necessary expertise.

RISK POLICY IMPLEMENTATION

WHO SHOULD BE RESPONSIBLE FOR THE IMPLEMENTATION

OF POLICY? WHAT DISCRETION SHOULD THEY HAVE AND

WHAT INSTRUMENTS / HEDGING TOOLS SHOULD BE USED?

Policy implementation tends to be delegated to the Corporate Treasurer inlarge firms and to the Finance Director / Controller in smaller organisations.We think this is appropriate for small and medium sized firms or businesseswith small volumes of uncommitted exposures. For firms with substantialvolumes of uncommitted exposures it may be appropriate for the CorporateTreasurer to be advised by a Hedging Committee. This group might includethe sales and purchasing executives and the Finance Director.The rationale for this Committee is that strategic exposure management is

less clear-cut than the management of transaction exposures. It may changeas a consequence of changing economic circumstances and the involvementof a wider management group will help identify the appropriate response.The Corporate Treasurer has the following specific responsibilities: -

He / She ensures that the desired risk profile is maintained

He / She solicits best advice from suppliers

He / She determines the most appropriate hedging strategy

He / She chooses the most appropriate instruments

He / She achieves efficient pricing

Of these five, the most important is the maintenance of the prescribed riskprofile. The choice of an appropriate hedging strategy needs carefulconsideration. It should follow discussion and consultation with the bankersand a review of the available instruments.
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What instruments or hedging tools should be used?

Common sense dictates that the firm should use any instruments orproducts, which promote effective hedging. The Corporate Treasurer, withan exclusive responsibility for the choice of products, should advise theHedging Committee of new products and convince the Committee as to howthey can deliver more effective hedging.The Corporate Treasurer should also ensure that the workings of these new

products are fully understood by all and give consideration to tax andaccountings aspects. Issues such as price liquidity and the reversibility ofdeals in these instruments and the credit risk, which might be associatedwith them, should also be considered. Last but not least, the corporatetreasurer must ensure new products can be captured on the appropriatesystems.

CONTROL AND SUPERVISION

Control and supervision is a hot issue in the world of risk management.Recent high profile losses have highlighted the need for a robust and reliablecontrol framework. An effective system is an integral part of procedure and

must be comprehensively addressed in a company's policy. Controls must bepracticed at all levels and the challenge is to convince managers that it ispart of business - and not, somehow, alien to it.

The key questions to ask

Who is authorised on behalf of the company and within what parameters?

How frequently will risk measurement take place and what exposurereports will be prepared?

What audit trails will be required and how regularly will they bereviewed?

Who will monitor cash outflows relating to hedge settlements?


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Who will reconcile confirmations and review documentation?

What role will the firm's auditors play in supervising limits and policyrequirements?

Policy must also incorporate another critically important feature of control.This is the segregation of the implementation function from the process ofrisk measurement, risk control and supervision of policy requirements. It iscompletely unacceptable that one individual should have responsibility for

both these areas. Segregation should ensure that abuse or disregard forpolicy stipulations will quickly be discovered. This is a fundamentalrequirement of an effective control system.If a segregated structure is put in place and the key elements are defined (inanswer to the questions above) one will then have a useful framework for

control and supervision.

PERFORMANCE EVALUATION FOR TREASURY

Performance evaluation is the Cinderella of risk management - a discipline

that rarely gets the attention it deserves. Yet without it the organisationcould leave itself open to inefficient practice in risk management through theblind maintenance of outdated hedging strategies.Performance evaluation must take place all the time. The feedback onereceives should then be used to continuously question and challenge riskmanagement strategy.An effective performance evaluation system will provide:Feedback on the effectiveness of the risk management strategyguidance on determining when the strategy should change.Evaluation of the efficiency with, which the strategy was implemented.

Information on inappropriate risk taking behavior

PERFORMANCE CRITERIA

Treasury should have a financial value-added objective as one of a series ofdifferent objectives. There should be correct balance between such


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objectives. Let us identify the performance criteria, which might be setdown.

Cash flow and liquidity management

A Treasury function should be evaluated in terms of its management of cashflows, its planning and its securing of the firm's future cash flows.

Observation of procedures and controls

The implementation of policy should be clearly and transparently segregatedfrom the risk measurement and supervision functions. These supervision

procedures should feature:1. An audit trail of cash flows.2. An investigation of documentation standards to include confirmations,mandates and masters agreements where applicable.

Treasury must also conform to policy in the area of bank limits and creditlimits in general. These should be checked and supervised.

Success in Strategic Long Term Risk Reduction

A Treasury unit is charged with transforming the natural financial riskprofile of a company to one desired by its senior management and directorsHowever reinventing such a risk management wheel year after year, is costlyand demanding. The Treasury function should therefore be obliged toexplore and initiate strategic changes, which reduce and eliminateunnecessary risks. How can one do this? Here are just a few ways.1. Highlight opportunities for changing invoicing policy.2. Advise senior management of opportunities for change in purchasing,sales and manufacturing policy, which would reduce financial risk.3. Pursue netting agreements with banks and other institutions where there isa two-way flow of business.4. Create matching asset and liability streams.

Service and support to the business divisions

Treasury operation must assist and support the business divisions. This

service can be measured using the following checklist.1. Does it raise consciousness and awareness of risks and opportunities?2. Does it help to secure new business and contracts?3. Does it seek to understand the underlying transactions so as to betterunderstand the issues?4. Is it efficient and responsive?5. Is it informative and proactive with advice?


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In short, does the Treasury function add value for the other business units?

Ensure best value from external providers of treasury services

It is not enough to evaluate a Treasury function in isolation. There is also areal need to ensure best value from external providers of financial products,especially those in the Treasury sectors.Competitive pricing for Treasury services is not the only issue. Real value ismore often achieved by ensuring long term relationships are developed with

banks and other service providers. Such a partnership yields greaterdividends in the form of best advice, innovative risk management solutionsand superior hedging strategies.

REWARDING TREASURY STAFF

Performance-related pay for Treasury personnel is an emotive issue. ShouldCorporate Treasury staff have a financial incentive to succeed in addingvalue or is there an inherent danger in such motivation? The arguments for

performance pay are simple.

In a market sector where such payments are normal, it's vital to linkperformance to pay to attract the best people.

Performance-related pay is a strong motivation and it helps peoplefocus on objectives.

Critics of such systems say it encourages irresponsible "speculation", a lackof focus on the non-financial elements of the job - risk containment, adviceand best service to the business divisions.Once again, argue that a balance needs to be achieved.A performance-related payment scheme that strikes the proper balance

between the different elements of good performance is the ideal. Theobjectives of the wider enterprise should become the objectives of theindividual. To do this, one must set up a transparent and credible evaluationsystem. A system that features a comprehensive series of objectives, whichare subject to regular review and assessment. It is suggested that addedfinancial value should only be one of these performance criteria.


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It's all part of the process of performance evaluation. One must make surethe standards for the assessment of personal performance are matched withthose of the unit as a whole.

New Tools for Treasury Management

In this section, we will review the many tools used by successful treasurymanagers to achieve the short-and-long-term financial and commercial

objectives of their firms. We begin with derivatives, the products, which areused to price and transfer financial risk. While there are hundred of productson virtually every exchange, a top-down view of derivative products fromthe standpoint of managing risk is useful. Therefore we will look atadvances in information technology, forecasting techniques, and lastlyadvances in the formation of capital.

DERIVATIVES: FUTURES AND OPTIONS

Once a facilitator of transactions, the financial officer or treasurer todayfaces many new daunting responsibilities. Among these responsibilities arethe uses of an array of new financial products, which have appeared inresponse to the growth in uncertainty described earlier. Risk is the spark ofinnovation leading to the creation of the financial derivatives industry.


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Modern derivatives markets provide a wide range of products linked to thekey factors affecting financial and commercial performance. Whether one isthe treasurer of a importing company or a Trans-national manufacturinggiant, external risk is endemic to business. Risks include interest rates,foreign exchange, equity values and commodity prices. Derivativeinstruments allow a treasurer to manage and find opportunity in the exciting

but uncertain world of modern business.

Begin with interest rate and foreign exchange linked derivatives markets,describing their general features, as well as offering perspective. Equity andcommodity linked derivative markets will be treated in a similar manner.With regard to managing interest rate exposure, we will address both thegeneric products used by treasurer as well as the swap markets. The interestrate swap market began in the United State where it remains the largest,

although since the mid-1980s the markets has taken-off in Europe and theFar East.

(A) INTEREST RATE OPTIONS

Begin with traded options and futures on interest rates, which one find, maybe divided into two distinct groups: First whether they are options on cash oroptions on futures; and second, whether they are options on short-terminterest rates or options on long-term interest rates. Although a wide rangeof options on long term interest rates, such as long dated bonds, trade aroundthe world, we will concentrate on the products and exchanges which aremost popular. Today the greatest liquidity exists in Euro-dollar futurestraded on the Euro dollar index. Options are traded on the LondonInternational Financial Futures Exchange (LIFE) and the ChicagoCommodity Exchange (CME), which offer an options contract on a longdated national $100,000 Treasury Bond Future. Options on the LIFEFutures Contract confer the right to buy or sell a Euro-dollar FuturesContract at a specific price on or before a specific future date. The CME

Contract calls for actual delivery of a Treasury bond against the contract,which is settled by reference to an Index on the Euro-dollar.

(B) INTEREST RATE SWAPS

Interest rate swaps have grown so popular as treasury products because theymake use of one partys comparative advantage in the capital markets.


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Strong issues of notes, such as British Petroleum or Ford, are able to borrowthrough fixed cheap rate funds. Weaker borrowers only have access tofloating rate loans. By exchanging their payment obligations through aswap, both parties are able to obtain a lower cost of funds. From this patternof strong issuer/weak borrower and the source of capital markets for credit,the swap market has developed into the primary method of managinginterest rate risk. This success has encouraged intermediaries to introduce adiverse array of further innovations, essentially derivatives upon derivatives,including interest rate caps, collars, floors and options on interest rate swaps

know as swaptions. By way of terminology, calls on interest rates areoften known as caps, while Puts on interest rates are often known as Floors.

(C) FOREIGNEXCHANGE DERIVATIVES

The main foreign exchange linked derivatives are currency swaps, longdated forwards, currency options, and combinations of the above. For

borrowers, access to currency derivatives ensures that they have access tothe lowest cost capital markets around the world. The integration ofinternational markets through foreign exchange derivative marketsencourages a competitive cost of capital. In addition to this integration role,foreign exchange derivatives serve a very real purpose. Foreign exchangefluctuations affect the competitive positions of companies, the cost of

borrowing abroad, and the returns on global investment portfolios. Precisecommercial and financial objectives can be managed through suchderivatives. Just as interest rate swaps involve interest rate futures andoptions, so are there currency swaps, linking futures and options in currencymarkets. Currency options and futures are among the oldest forms ofoptions and futures products. Traded currency options are divided into twotypes: Options on cash, and options on futures. A Cash Currency Option isthe right to buy or sell a fixed quantity of one currency in exchange for aspecific quantity of another currency in a ratio determined by a specificexchange rate at or before a specific future date. A Futures Currency Option

is the right to buy or sell a traded currency futures contract at a specificfutures price at or before a specific date in the future. The LondonInternational Futures Exchange (LIFE), the Philadelphia Stock Exchange,and the Chicago Mercantile Exchange, all offer futures, options, and optionson futures as a means of hedging and speculating on foreign exchange risk.Using these products, many banks make markets in more complicated


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foreign exchange linked derivatives such as currency swaps and long datedforwards, and combinations of the above.

For borrowers, access to currency options and futures derivates ensures thatthey have access to the lowest cost capital markets around the world. Inaddition to this integration role, foreign exchange derivatives facilitate thetreasurer's role in asset management. Foreign exchange fluctuations affectthe competitive positions of companies, the cost of borrowing abroad, andthe returns on global investment portfolios. Precise commercial andfinancial objectives can be managed through such derivatives.

(d) EQUITY LINKED DERIVATES

The late 1980s saw the growth in modern derivative products applied to

equity markets. Just as the growth of interest rate derivates spurred theinnovation of foreign exchange derivatives, thereby linking internationalcapital markets; the emergence of equity derivatives was almost inevitable inorder for the risk/reward profile of equity investments to remain competitivewith the fixed income offered by debt instruments, such as bonds. Equityderivative instruments allow treasurers managing portfolios and pension ameans to structure requirements in terms of market timing, and risk/reward

profile. Importantly, the use of equity derivatives has changed the nature ofequity portfolio management. Traditional techniques such as fundamentaland technical analysis, diversification strategies, and asset allocationstrategies now rank along side derivative risk management as means ofachieving investment object ivies.

e. COMMODITY LINKED DERIVATIVES

Unlike the issuer/borrower and investor/lender pattern of participation seenin the derivative markets described above, the treasurers of producers,refiners, and consumers of the worlds materials use commodity derivatives.The original derivative market, commodity derivatives satisfy the needs of

participants to manage price risk. Commodity price risk often forms thecore business of users such derivatives. Liquidity, solvency, and possiblyeven survival demand the use of derivatives. Today, active users include thetreasures of oil producers, airline companies, electricity generationcompanies, mining companies to mention only a few. Treasurers workingwith lenders and investors to ensure the returns and carrying capacity of new

projects are also using commodity derivatives.


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For Treasury Management, derivatives markets provide a wide range ofproducts linked to the key factors affecting the financial and commercialperformance of their organizations. Whether one is small domestic importeror a trans-national manufacturing giant, external risk is endemic to business.These factors include interest rates, foreign exchange equity values andcommodity prices. The power of options, futures and other derivativesinstruments to manage and find opportunity in risks, explain the growth ofthese markets, and are the reasons for their continued use.

FORECASTING TECHNIQUES

Among the many important new tools, which Treasury Management mustlearn to adopt and utilize, are those involving Forecasting. Forecasting

relates to capital budgeting, planning; the use of derivatives for riskmanagement, technology choices, and a host of other things. Although thescience of forecasting is an enormous topic involving such fields as statisticseconometrics, and computer simulation techniques, we will make note ofsome guidelines relevant to the task of Treasury Management.

In virtually every decision made by treasurers, there is some kind offorecast. The outlook for interests rates, demand trends for consumer items,the speed of technological change, the impacts of government policy. As itis surely better to forecast such items explicitly, rather than taking them forgranted or using erroneous inputs; the methodology of forecasting deservesattention. The selection of methods depends on many factors, including butnot limited to the following:

FORECAST SELECTION METHODS


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TYPES OF FORECASTS ERROR

Phase Error One has the trend and direction correct but the timing is

off. Perhaps a lag or lead structure should be introduced. Specification error Ones casual model suggests the inverse

relationship to what is observed as the future unfolds. Remodel thetheory behind the forecast.

Bias Error The model is on the trend and neither leading nor laggingthe real world, however, it regularly over or under predicts.Reconsider the constants in the equations.

In closing remember that the future is unknowable. All we can hope to do isplan in an intelligent manner. The resources devoted to forecasting and thetype of errors in forecasting acceptable should be related to the tasks facingmanagement. While it is recommended that forecasting become one of thekey activities of Treasury, it should be remembered that some of the world/smost successful products, the most successful projects, the most successfultechnological innovations were not the result of planning, but ratherintuitive, inductive leaps.

INNOVATIVE FINANCING TECHNIQUES

On the basis of long run plans the financial manager must raise the capitalneeded to support the firms growth. Traditionally, investors participated ina corporation by either purchasing its equity, ie buying shares, or making thecorporation a loan, i.e. buying bonds from the corporation. While both suchmethods remain overwhelmingly the dominant method of capital formation;it is useful to make note of innovations in the area of hybrid securities. Theyare known as hybrid because they are often constructed synthetically in the

financial engineering departments of investment and commercial banksusing off the shelf products. For example, an ordinary share might be

bundled with options, or a new security might be constructed based upon therelationship of traded securities. The purpose of all such hybrid securities isto allow the treasurer to access the funds of potential investors wishing toexpress complex view on the market. One purchases shares in theexpectation of capital gains and dividends a bullish view. But how might


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an investor express the view that the share will rise, but the industry ofwhich it is a component will decline? Or suppose the performance of a firmwere closely tied to certain commodities, such as petroleum. Perhaps ahybrid security, which took into, accounts the affect of general pricemovements in the commodity upon the security itself. The point then is that

by designing and using hybrid securities, financial managers may be able toaccess capital which otherwise would have found the investmentuninteresting. The well-known junk bonds were really just a hybrid between

bonds and shares, because their performance than interest rates andreinvestment risk. Innovative financing using hybrid securities is anothertool for Treasury Management to accomplish the critical role of capitalformation.

A TREASURER'S GUIDE TO

COMPUTER SYSTEMS(SYSTEMS, TECHNOLOGY AND THE CORPORATE

TREASURER)

Control

It seems that as one control scandal dies down, another replaces it. It isrequired to impose of controls in the critical areas: separation of duties

between front, middle and back offices; deal confirmation issuance andchecking; the proper authorization of outgoing payments; and in theindependent pricing and valuation of positions and exposures. Theimplementation of secure systems is an essential element of setting up a

properly controlled treasury environment.

Processing Facilities

Many older computer systems lack the scope and flexibility to managehedging instruments such as swaps, options and FRAs. Treasuries who areforced to rely on insecure spreadsheet fixes are vulnerable to errors andfailures. The replacement of inadequate systems frees treasury personnel


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from mundane and ultimately unproductive tasks, to concentrate on theirprofessional duties of treasury and risk management.

Integration

Treasuries supported by inadequate systems usually have to re-key the sametransaction into a series of systems, which cannot communicate with eachother. In extreme cases, these systems may separately address the functionsof deal tracking and valuation, confirmation, accounting, payment

processing, bank statement reconciliation and management reporting. Re-keying is of course a wasteful occupation, and it introduces inevitably higherror rates. Contemporary systems allow treasury departments to entertransactions just once; subsequent processing, including interfacing withinternal and external systems, is achieved automatically, with the impositionof prudent verification and control steps.

Reporting

Every treasury has unique reporting requirements. These reflect such diverseissues as the corporations structure and business, managements approachto treasury control, the Treasurers interpretation of the needs of riskanalysis, and the companys cash forecasting environment. These

requirements are met through a modern systems use of powerful reportwriting engines, which give the Treasurer freedom of access to the entiretreasury database and to industry standard and user-specific calculations.

Risk Management

Todays focus on risk management means that treasury departments areexpected to be able to quantify and analyze treasury exposure and riskquickly and easily. Treasurers require the tools to quantify a number ofvariables, such as positions, mark-to-market valuation, Value at Risk and the

bottom line consequences of hypothetical What-if? scenarios. Asophisticated and powerful system is an essential component in thefulfillment of this requirement.

THE FIRST STEPS


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A common error, which has been repeated countless times over the historyof computer systems, is the automation of flawed and outdated processes.This error simply institutionalizes inadequacy, and makes its subsequentrectification even more difficult. With this in mind, the following processsequence is recommended for treasuries who have decided to embark onsystems replacement:

Review the existing systems and methods.

Develop a strategic plan, defining the ultimate goals in terms ofresults, processes, reports and interfaces.

Survey the marketplace.

Define the project objectives and budget.

Select the system.

System implementation.

The Review

This is perhaps the most mundane aspect of the process, but it is essential todevelop a coherent, systematic understanding of the problem before aneffective solution can be contemplated. It is useful to employ business

analysts even at this stage, especially if such a resource is available in-house.The objective is to document the flows of all the processes in the treasury.This exercise alone will pinpoint the weak spots, by revealing theinefficiencies, labour-intensive redundancies and risk points. It may evenindicate where interim measures may be applied as a temporary solution to

pressing problems. But, most significantly, the Treasurer will havedeveloped a documented basis from which the subsequent creative processcan build.

Strategic Plan

The construction of an innovative strategic plan follows logically from asystematic definition of the problem. The failures and omissions of existingsystems and methods will have been clearly identified, and therefore therequired solutions may be defined and prioritized.
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The details of the strategic systems plan will naturally vary from company tocompany, but a typical result is likely to encompass at least some of thefollowing points.

Control elements: the processing of transactions.

Reporting requirements: functional definitions of the key reports to begenerated.

Critical import interfaces: bank statements, forecasts, and subsidiariestrade requests; netting cycle inputs, market rate information.

Critical export interfaces: bank payments and pre-advices, electronicconfirmations, General Ledger Accounting system entries (detail orsummary), MIS information, netting results.

Communications requirements: communications within the treasury,communications with other departments, inter-linking of subsidiariesand regional centres with Headquarters.

Technology considerations: internal standards for operating systems,database management systems, networks, hardware, E-mail,spreadsheets.

Risk management: treasury and corporate requirements for monitoringand managing risk.

Time constraints: how time critical is the production of the variousinformation sets, processes and reports?

Market Survey

Now that the Treasurer has a planned set of systems objectives, it isappropriate to survey the market to determine which systems generally meetthe companys strategic requirements.

There are many potential sources of information. Treasury conferences andwell-attended conferences are a primary source of up-to-date information.The system suppliers will of course be there, showing their systems to bestadvantage, but perhaps the most valuable source here is presentations andconversations with other treasurers who have recently been through thesystems selection process. Interestingly, there is a solidarity among


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treasurers that seems to transcend corporate rivalries, and there is someevidence that peer group collaboration plays a significant role in gatheringuseful information.

Not surprisingly, specialist treasury publications frequently carry articles

about systems and technology, by suppliers (such as this one), consultantsand treasurers. Prudent treasurers will of course take advantage of othersexperiences, and the market seems to be well served by the coverage ofrelevant topics.

Many treasurers turn to the services of their in-house systems departments orto external consultants at this stage of the process. The role of in-housesystems departments has evolved rapidly over the last few years. Whereonce their primary role was systems development, this has now, in manycases, changed to internal consultancy, especially in support of the selection

and implementation of systems. External consultants naturally bridge thisgap when in-house expertise is unavailable.

The end result of this phase of the process is a list of treasury systemsuppliers whose products meet the content and quality parameters ofthe project.

Project Definition

At this stage, the Treasurer is in a position to define the objectives of thesystem selection project, and to request funding for the chosen solution. It is

best to delay budget finalizing until this point, since in practice the scope ofthe project may quite reasonably increase in the light of studying themarketplace (a decrease is unlikely!). The Treasurer will have discovered the

broad scope of new developments in systems and technology, and will havea much better idea of its practical value in the treasury environment.

The process of defining project parameters should be relativelystraightforward, since the general definition of the plan should be a

pragmatic expansion of the strategic plan, in the light of expandedinformation set.

The projects definition may need to be supplemented by a cost/benefitanalysis, and a number of caveats apply to the preparation of this. A newsystem is an essential tool in advancing the treasurys performance andgoals, and its selection and implementation are the beginning of the process


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of achieving those goals. The actual goals will of course vary from treasuryto treasury, and they may range from the tangible benefits of reducingoperational costs, optimizing bank account management, reducing fundingcosts and increasing investment returns, to intangibles such as theimprovement of control and risk identification and mitigation. It is unlikelythat all of these can be concentrated into a single project, so the Treasurerhas the opportunity to prioritize objectives and refine the departmentsmission.

1 Treasury Management System Selection Process


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2 Client-server Technology applied to a Treasury


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Systems Selection

A typical process is illustrated in Chart 1 Treasury Management System

Selection Process.

Prospective system purchasers often issue an RFI (request for information)to a long list of suppliers, in an attempt to identify a short list. This alone is atime consuming process, and there are a number of publications such as The

Buyers Guide to Treasury Management Systems Worldwide (Authors: KenLillie and David Middleton, published by The Bank RelationshipConsultancy), which may help to truncate or even, bypass it. The Treasurerscontacts are again useful; a few telephone calls to contacts at companies whouse the contemplated systems may well establish particular systemsuppliers suitability for the task in hand.

The selection process inevitably brings the issue of technology to the fore.Most treasurers now have direct experience of PC technology through bothhome and office computers. PC power and price continue to follow aninverse relationship, and the dominance of Windows has resulted inuniversal user friendly computing. Nonetheless, one key aspect of the
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selection process is weighing the benefits of the different technologies thatwill be presented by competing systems. The decision will affect manyaspects of the project, including cost effectiveness, performance, flexibilityand future upgrade path.

The price/performance ratio of PC workstations has been dazzling, andindustry specialists see no abatement in this trend until the ultimateconstraints imposed by the Laws of Physics are confronted. Within the lastdecade, the standard desk-top PC has evolved to the 200 MHz Pentium,and the implications of this advance are understated by the logarithmicnature of measuring processor speed using MHz. It is now cost effective touse large amounts of memory, which means that more data and programinstruction is instantaneously available to the processor. Contemporaryworkstations are now able to offer top levels of performance to exploit the

full power of Windows NT and other multi-tasking operating systems, sothat several tasks may be executed virtually simultaneously on oneworkstation. The best advice for workstation purchasers is to buy top of therange equipment, to minimise performance issues in this area. Treasurersoften ask how long should the write-off period for workstations be, and Ihave heard answers recently that range from two years, to zero! In any event,this is an area in which the value of virtually any economy seems to be false,since it is in the nature of the designers and developers of computertechnology to exploit innovations to the full. The treasurer may reasonablyselect a new system to last for five or ten years, but he or she should be

resigned to review hardware on a two-yearly cycle.

The relationship between hardware, network and database managementsystem has much in common with the theory of convoys, which are as fastas their slowest ship. System selection in this area may be subjected to anumber of in-house constraints, and expert technical advice should certainly

be sought. Most contemporary treasury systems are built using client-servertechnology, which is illustrated in Chart 2 Client-server Technologyapplied to a Treasury. The interactions of the various components of aclient-server system are intricate, and need to be optimised in pursuit of the

treasurys performance objectives for their new system.

The selection of the database management system may be constrained byinternal standards; for example, many European companies are now usingthe Microsoft SQL Server or ORACLE databases as corporate standards.The benefit for the Treasurer in selecting a system that supports an internalstandard is that he or she should be able to call on in-house expertise for the
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installation and management of the database in the course of systemimplementation and operation. This role is often formalised in theappointment of a Database Administrator or DBA who may be a computer-literate treasury analyst.

LANs (Local Area Networks) are another area which has seen a recentquantum increase in speed; the standard treasury LAN performance is

presently shifting from 10 Mbps (Mega bits per second) to 100 Mbps, andtreasurers should be assured that potential new systems can take advantageof this increase. If treasuries are inter-connected using a WAN (Wide Area

Network), it is often the performance of this link, which is the criticallimiting factor. WAN performance is affected by many variables, includingthe configuration of the database management system and the network

protocol, and projects involving WANs require a relatively high degree of

technical input.A final technical issue is the systems development plans for use of theInternet. Today, the Internet is not a suitable vehicle for the secure, efficienttransmission of large amounts of data, but it is virtually certain that this willchange in the near future. It is likely that companies will be able to use theInternet for cost-effective treasury communication with a network ofsubsidiaries, and treasurers should ensure that this pathway would be open tothem with their new system.

The selection of a system which meets a treasurys functional needs is lessdaunting to the Treasurer, since this part of the process involves verifyingthe prospective systems relative handling of treasury business, against theestablished strategic plan. Many treasurers use the RFP (Request forProposal) approach to evaluate systems and suppliers, and the completion ofresponses to good RFPs present suppliers with an onerous (and revealing!)task. Suppliers sometimes complain that some RFPs are poorly edited andrepetitive, and certainly questions that can be answered using copy & pastefunctions should be avoided. The art of RFP writing is to establish thedifferences between critical elements of different vendors solutions, and

these are best revealed by How do one...? as opposed to simple Doone...? questions. A proper market survey will have revealed the answers tothe latter form of question.

MCM advocates the use of structured work sessions as the key step in thesystem selection process. Essentially, these involve setting an agenda withseveral system suppliers for a detailed review of the system. This should


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involve hands-on experience of the system, and a review of the systemsresults when processing a representative selection of typical transactions.The Treasurer needs to ensure that the chosen system can produce theinformation required, through a review of system processes, portfolioanalysis and report writing techniques. The end of this demanding processshould accurately reveal the competing systems strengths and weaknessesin meeting the goals of the treasurys strategic plan.

Aside from the issues of technology and functionality, system buyers need tobe assured in areas such as the depth and quality of the prospectivesuppliers support operation, of their stability, and their long-termcommitment to the corporate treasury marketplace. These areas are bestaddressed through contact with several reference sites, and the vendorshould be asked to introduce several companies, which have successfully

achieved similar goals to the buyers own. Ultimately, the decision is taken on a range of concrete and abstract

issues, and the project enters the transitional phase of contractnegotiation and finalisation. Purchasers are recommended to agreecontracts, which include clear definitions of project deliverables andmilestones.

System Implementation

MCM firmly believes that implementation must be a structured process, andthe client treasury department must enter i

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