Is your Treasury Policy Fit for Purpose in a Changing World?

It is difficult to argue against the necessity for an unambiguous Treasury Policy. It protects the Board by setting the clear rails and parameters under which the funding, liquidity, investments and treasury risks are managed. It also protects the finance function by providing defined authority limits and acceptable risk tolerance levels.

Unfortunately, it is commonplace for the Treasury Policy to roll from year to year, through the Board cycle without the changing banking landscape and macro factors such as interest rate changes being assessed. It is also imperative to update the Treasury Policy as business models evolve and expand, either by jurisdiction or product.

A strong risk management culture should also support the inputs into your Treasury Policy and Risk Management Framework. On-going risk management activity should include a program to identify, measure, control, monitor and report key risk types. An appropriate Early Warning Indicator (EWI) process can be established to ensure the risk environment is monitored and management can be put on heightened awareness if systematic or idiosyncratic criteria are breached.

Depending on the profile of the organisation the following are the key components which may need to be considered:

1. Governance:

Are the Board directly responsible for the Treasury Policy oversight or has this been delegated to a sub-committee of the Board (Management Committee/ Executive Risk Committee)? Do all stakeholders and individuals know their specific authority levels and are the interaction / handoffs between teams clearly defined?  Have the Board formulated a defined Risk Framework which establishes Risk Appetite levels, either qualitative or quantitative?

2. Funding:

The Funding Policy should work in tandem with the Board approved Financial Plan. It should outline the sources and levels of funding required. Are funding concentration risks addressed or high level contingency funding options considered?

3. Investment Portfolio:

This is likely to be very topical as the Board / CFO look to maximise interest income from excess cash balance. Operational considerations should ensure cash puddles are minimised and pooling structures are utilised to consolidate cash positions across the organisation.

The Policy should clearly outline the purpose of the investment portfolio such as:

• a store of liquidity,
• manage interest rate risk,
• credit diversification,
• provide collateral for secured borrowing,
• manage FX risk and
• provide favourable investment returns.

The Policy should clearly articulate eligible investments, maturities and counterparty limits, in conjunction with Credit Policy. The Board may also wish to integrate ESG criteria within the Investment Portfolio.

4. Liquidity:

It is imperative an organisation documents a formal Liquidity Policy to clearly articulate the necessity to meet cash flow obligations as they fall due. It is also important to maintain liquidity through stressed conditions. Metrics can be developed such as Total Available Liquidity (TAL) and survival horizons to better understand the dynamics of cash flow cycles and access to excess liquidity.  These metrics can be utilised to formulate a Risk Appetite Statement which outlines appropriate liquidity buffers and sets liquidity targets, triggers and limits. The Treasury Policy will stipulate at what point a trigger event will occur and the escalation process.

5. FX exposure:

It is important to understand the currency dynamics within an organisation in order to formulate Policy parameters. Operationally, many banks offer multi-currency accounts but the pricing can vary greatly depending on the outbound / inbound conversion terms. In general, for high volume currency pairs such as EURUSD, EURGBP and GBPUSD the spread and margin can be somewhere between .5% to 5% and for lessor traded currency pairs it can be up to 8 or 9 %. The transparency around these charges is poor and very often the finance teams see a debit and credit amount and infer the FX rate which hides the excessive fees.

The Treasury Policy should agree the parameters for monitoring FX exposures, assign limits and agree permissible currencies. One option is to run and monitor a currency split Balance Sheet. This will identify all the non base currency exposure which will revalue. Appropriate limits can be assigned to cross currency pairs. It would be beneficial to differentiate between the types of FX exposure, be it transaction (non euro activity), translation (remeasurement of non euro asset / liabilities) or economic (future cash flows / investments). FX hedging via FX SWAPS is an option to mitigate FX volatility but care needs to be taken to ensure the future cash flows are known with a degree of confidence. Otherwise the FX SWAP could be opening an FX exposure instead of mitigating it.

6. Interest Rate Risk Management:

Large maturity gaps between assets and liabilities can create an exposure as yield curves move. Maturity mismatch buckets or net interest simulation techniques can be used to better understand the dynamics of the interest rate exposure within an organisation.

7. Payments:

Sometimes this section is considered under the Operational Risk Policy. It is important the control environment around payment initiation process doesn’t fall between the finance and operational risk function. A strong control environment could include:

• pre-approved locked payment templates
• segregation of duties
• four eye approval
• call back for new settlement instructions
• input/ approval limits.

At Bankhawk, we see three emerging trends which will shape the banking sector in the medium term and should be considered as Treasury Policies are updated:

• Higher Central Bank rates: Most banks are reluctant to pass on continuing interest rate hikes, this is evidenced by the higher Net Interest Margins (NIM) earnings reported in the banking sector. Organisations may need to build out the capability to expand investment activity to monetise higher rates. In addition, the excess liquidity which was historically provided by Central Banks to the banking sector will dry up, this will lead banks to increase pricing on debt facilities and the provision of intra day liquidity.

• Digitalisation / Open Banking: We have already seen how neo banks have captured market share from traditional retail banks. In Ireland, Revolut has 1.9 Million customers. We expect this trend to move into the Corporate space, with opportunities to reduce and provide greater transparency in FX costs and alternative payment types, such as account to account (A2A). One independent report, sponsored by Wise, concludes Fintechs can provide FX transactions in Ireland 4 times cheaper than the two pillar banks.

• Credit Monitoring: Traditional rating Agencies tend to monitor and track idiosyncratic threats after the event. Historically, bank runs have manifested slowly as concerns build and the customer base withdraw cash deposits. Bank runs in the modern era have escalated much quicker due to 24/7 on-line access to move deposits and the proliferation of social media which can fuel the negative news cycle, perpetuating a self-fulfilling prophecy. The risk of contagion is also exacerbated as social media quickly speculate on peer banks. We witnessed this phenomenon recently as a large section of regional banks in the US suffered from a reduction in their deposit base as Silicon Valley Bank collapsed. Real time monitoring, using Credit Default Swaps (CDS), can give a better real time assessment of the credit risk profile of a counterparty.

Please feel free to reach out to Bankhawk for a free, no obligation discussion surrounding your Treasury Policy requirements and how you can position your organisation to leverage and mitigate these emerging trends.