Treasury and Commodity Risk Management
Posted: Jul 14, 2016
A volatile global economy requires an integrated method to treasury management for commodity-exposed firms. As globalization continues, several firms are exposed to substantial levels of currency and commodity risk on a daily basis.
Currency risk is a factor not only for multinationals located across various currency zones but for any firm dependent on imports/exports. Again, commodity risk is an issue for any business exposed to resources at any point in its supply chain.
Traditionally, these functions have been managed distinctly. Currency risk is usually the domain of the treasury, managed by the CFO, and naturally handled on traditional treasury management systems (TMS) through hedging.
On the other hand, commodity risk is overseen by the procurement division and is usually mitigated by locking in volumes and prices over longer periods.
However, some recent market trends have combined to challenge this approach:
The unexpected decision of the Swiss National Bank to unpeg the Franc in 2015 sent its value falling. This highlights the increasing volatility of the existing currency markets. Continuing uncertainty about the robustness of the international economy in the context of unstable monetary policy would drive increased currency risk in the future. Markets have become extremely sensitive to central bank announcements.
In recent times, a wide range of commodities has retreated from the highs of the past decade, fluctuating significantly all along.
Lower prices could benefit certain commodity intensive firms with regard to the margin, but upward trends in volatility have challenged the limits of traditional stand-alone procurement strategies.
The growing tension between increasing global demand and comparatively fixed supply indicates this volatility is expected to continue in the medium-term.
Increased Risks and Strict Regulation
The increase in currency and commodity volatility combined with new regulation is driving an increased understanding of risk and steering a requirement for more powerful enterprise risk and credit management.
Regulations like MiFID II and Dodd-Frank could force several non-financial corporates to modify their management of cash and collateral, improve visibility with regard to capital adequacy and deliver- decision-making tools around hedging.
CFOs are becoming aware of the in-depth interdependence between currency and commodity risk. Steep movements in forex markets could impact procurement decisions, and advanced financial hedging could protect against commodity price fluctuations.
At the same time, traditional procurement strategies developed around fixed contracts for volume and price are leaving firms exposed during the durations of high volatility.
Financial decision makers with an ability to manage commodity and currency risk in a very centralized way could gain a vital edge over competitors.
Improvements in Technology
A decade ago, managing currency and commodity risk from a distinct location would not have been possible. Doing so through outdated systems would have been extremely challenging. However, it is not the case at present.
There is an increasing trend towards highly sophisticated, centralized technology platforms. The existing treasury management systems facilitate the integration of commodity procurement with treasury management, providing CFOs a distinct, transparent and on time view of risk (commodity, cash, and currency) throughout the enterprise.
This transformed environment has effectively made the siloed method to currency and commodity risk management outdated. Inefficient risk management converts directly into increased costs.
Commodity-intensive firms could either pass these inefficiencies onto customers or invest in a sophisticated, integrated, enterprise-wide approach to treasury management, fit for commodity intensive firms functioning in a volatile environment.
By eliminating the barriers between commodity procurement and treasury, a firm can get a holistic view of risk and opportunities to improve margins, while also decreasing costs.
A sophisticated treasury system would enable the treasury function to play a greater role in risk management across the business. It can also enable a firm to automate and manage all the global currency, commodities, and interest-rate swaps on a distinct platform, thereby decreasing the overall costs.
In firms that have traditionally separated treasury and commodity risk management, there is a robust investment case for consolidating risk from a people, process and technology aspect.
This is increasingly evident as the treasury has appeared as a strategic partner of the business, supporting the assessment and implementation of commercial transactions.
In order to accomplish an effective consensus throughout the organization, firms must adhere to certain basic steps:
A Vision Statement
- It provides an insight into the organization’s aspiration to overcome challenges relating to treasury and commodities risk.
- Integrated systems enable the organization to do more tasks in a shorter time. This assists in improving productivity.
Lessening Operational Risk
- New technology solutions can provide better methods of accomplishing expected operational outcomes.
Embedded Control Framework
- Embedding the risk policy of a firm into the core of operational systems enables management to operate in a prearranged environment.
Standardization & System Rationalization
- Processing transactions in a standardized manner lead to efficiencies in the effort. The benefits to be achieved from integrating business functions have led to a reduction in the total systems and related expenditure.
The trends steering the integration of treasury and commodity procurement are going to continue in the future. Corporates that are active in the commodity markets have started following this approach. At present, due to the increased pressures of competition and volatility, it would be appropriate for commodity intensive corporates to follow the same approach.
Christine is an experienced freelance business and finance writer. Currently writing for Academy of Financial Trading reviews.