TOM DUGGAN: Allow me to introduce you to Peter Seward. Peter is the Vice President of Product Strategy at Reval and responsible for the strategic direction of Reval’s SaaS/Web-based platform, and the Reval Center valuation hedge accounting service. He has also written the modules, Reval IAS 39 and the FAS 161 Doctors. Peter has over 15 years experience in the financial services software business spanning Asia-Pacific, Europe, and North America. Prior to Reval, he was sales engineer at Principia Partners and custom development project manager for Integrity Treasury Systems in both Sydney and Chicago, and also was manager of treasury systems at Rabobank in Australia in Sydney. He holds a bachelor of science in mathematics and economics from the University of Western Australia. So I’d like to turn it over to Peter and Reval. Thank you.
PETER SEWARD: Thank you, very much, Tom, and it’s a great pleasure to represent Reval to present the 2010 Alexander Hamilton Awards for financial risk management. First of all, I’d like to congratulate the three companies represented here today: Microsoft, Visa, and Thomson Reuters. And they’re represented: Visa by Alan Weindorf, Microsoft by Joel Combs, and Thomson Reuters by David Shaw.
Now two of the presentations today cover currency hedging, so I just wanted to spend a couple of minutes just talking about FX risk and the current state of the markets and what corporates are facing, particularly in evaluating their own exposures, and more importantly, communicating to external stakeholders within their companies what exactly they’re doing as regards to hedging. And so a lot of treasury professionals talk shop and have a very solid understanding of different hedging strategies, evaluating risk, etc.; but in the last couple of years, they’ve probably been inundated by requests from their board to explain, you know, the impacts of various Fed decisions, changes in currency movements, etc., and really to justify exactly what they’re doing and to give help and guidance and counsel about what might happen in the future.
So a tool that can be used internally and externally to communicate what treasury is doing is value at—oh, sorry, cash flow at risk, which is a close cousin of value-at-risk, which is mentioned in one of the submissions. And cash flow at risk is a simulation tool which allows you to look at future scenarios, as many as you might wish, to get an understanding of what might happen with your exposures and your derivatives hedging them. So it’s a means of understanding your risk and a means of evaluating your risk and alternative hedging strategies, and finally, a tool to communicate to external stakeholders in a simple way exactly what choices you face and what decisions you’re making.
So in the last couple of years, it’s fair to say FX hedges have been heavily impacted by the external environment. So there’s been a plus or minus 20% increase in the major—change in the major spot rates: yen, euro, GBP. Sales forecasts have often been volatile because of uncertainty around the global economic environment, and banks have been very strong in enforcing credit requirements and sometimes limiting the time horizon that corporates can hedge. So the sum of these three factors is really increasing the variability of any unhedged profits for corporates.
So very quickly, if we look at the FX rates of yen, euro, and GBP since 01-01-2008, you can see that there’s been a great deal of volatility; that there’s one currency that’s a little bit hard to see. But in short, the yen has increased over 30%; the euro has decreased over 20%, but is making a recovery; and the GBP has similarly decreased, probably even further. Now I’ve marked on the chart there QE1 and QE2 just to give an example of the type of external shocks that corporate FX hedges are facing, and the QE1 and QE2 represent the times at which the quantitative easing by the U.S. Fed kicked in and what effect it had on market rates. And you can see that the dollar weakened back in 2008 when it was first introduced, and the current speculation about a QE2 is having, again, a significant impact on currency rates. The general point here is that these are external factors outside the control of treasurers and treasury, and so the decision to hedge, how much to hedge, when to hedge is heavily impacted by these external factors.
So now I’d like to just turn to a couple of very simple examples to show the application of cash flow at risk. So I’m looking here at a U.S. entity, which has an exposure in one year to a $1 million-euro. So I can generate a simulation, and the simulation here was done using historical market data over the last four years and 500 simulations. And you can see there’s variability in the outcomes there. It’s roughly symmetric, and I can lose or gain around or about $70,000 to $80,000 on my exposure. So I get a simple idea of the risk I’m facing with my forecasted exposure here. Now, I can decide to hedge that exposure. I’ve got a lot of choices. So FX hedgers know that, you know, they can hedge a percent of that exposure with a forward, they have options, they have complex structures like participating forwards, collars, etc.
And cash flow at risk is a useful tool to evaluate the impact of alternative hedging strategies on that exposed risk. So if I decided to hedge that exposure two-thirds with a FX forward, what would be the impact? So I can see very clearly my exposure, being the brown bars there, still is plus or minus $80,000, but my FX forward—the green bars, with the exposure, so it’s my hedged portfolio—has narrowed the risk substantially. So I’ve eliminated the tails, but unfortunately I’ve eliminated both tails. So I’ve traded off my downside risk and my upside risk for certainty. If I then decided, okay, what would be the impact if I hedged 100%? Obviously, I’ve eliminated all the risk. So very easy to communicate to external stakeholders what is the impact of the different hedging strategies that I’m thinking about. Again, if I take my example and look at the exposure again, and then my bank calls me up and says, well, I’d like to sell you a participating forward, which gives you 50% forward cover and then a 50% option on the downside risk, so leaving you open to make some gains. Again, I can run my scenario analysis and I can see that I’ve eliminated a lot of the risk, more so on the downside; I’ve centered my outcome; and I have some potential upside risk.
So these graphs are very simple. They’re output from cash flow at risk. They’re very useful for treasury, firstly to understand their risk, then to evaluate alternate scenarios; but more importantly, probably in the last year, to communicate to less sophisticated or less technically savvy —financial risk professionals what exactly they’re doing and how they’re trying to reduce risk and not necessarily make profits.
OK, so thank you very much for that. Just as a recap, cash flow risk really allows you to understand your risk, evaluate strategies, and communicate to external stakeholders. So without further ado, I would like to move on to presenting the awards for financial risk management.
And the Bronze Award goes to Visa, represented by Alan Weindorf. Alan is the senior business leader at Visa, a global payments technology company. He joined Visa in early 2008 to manage the international FX activities after leading a series of consulting projects prior to Visa’s IPO. Prior to Visa, Alan worked for Starbucks, where he managed enterprise risk management, investment management, and capital markets functions. Alan was also assistant treasurer at Transamerica Corp., where he directed asset/liability management and interest rate risk management activities. Alan is a graduate from Stanford University, serves on GARP’s FRM Committee, and in 2005, was one of Treasury & Risk’s 100 Most Influential People. So congratulations, Visa and Alan, on winning the Bronze Award.
ALAN WEINDORF: Thank you. Good afternoon. You know, I just wanted to start by thanking Treasury & Risk for gathering us all here today. It’s always a pleasure to come and share best practices, and obviously by today’s attendance, I see thatwe’re all well represented. I also wanted to thank Peter for those kind words. The project I’m going to be talking about actually involved a Reval solution, which I’ll get to. So I certainly wanted to thank Reval and, in particular, I saw Robert Pierson who headed our implementation services team, who did just a fantastic job during our FAS 133 middle- and back-office solution; and also three individuals from Visa who really led the effort, and obviously as we all come up here today I know we all have people behind us who make what we do so successful, but Susan Wu from foreign exchange from my team, Alan Tam from accounting, and Ryan Hess from our financial systems teams just did a fantastic job.
I’m not going to spend a lot of time talking about what Visa is and what we do. You know, I think most people are familiar with the brand, they’re familiar with the product whether it’s a debit, prepaid, or credit. Visa has been a longstanding leader in global electronic payments, really trying to push forward the idea of digital currency. So hopefully everyone uses our product, knows of our product, and we can certainly talk offline either at lunch or during a break or at the banquet tonight a little bit more about what Visa does.
But what’s interesting about Visa, and one of the reasons I wanted to come to Visa three years ago when Visa was transforming from a bank association—really a club of, you know, the U.S. domestic and the international banks owning Visa as a shared service—to a for-profit public company, was the opportunity to come onboard, look at the legacy systems, legacy processes, and really challenge what we currently did to try to make things more efficient, more streamlined, and quite frankly, more profitable. And in doing so, and putting together the road map as we all put together our own technology project road maps, you know, FAS 133 was on the list. We had, as everyone probably in the audience has, an existing hedging process, front, middle and back office. We at Visa, as I have in the past, used a fairly rigorous front-office process; we actually use value-at-risk extensively at Visa. We used it obviously at Transamerica doing ALM, I implemented it at Starbucks and in various consulting roles, you know. Visa was a natural place to implement and extend our value-at-risk model.
It’s important. Foreign currency is our single largest exposure, once we get past credit risk. And when we examine our portfolio of our top 20, 25 currencies, our challenge wasn’t so much understanding where those risks lie or the volatility of the underlying cash flows with respect to business conditions; we’ve got a fairly consistent business model. You know, we don’t have the volatilities that we saw earlier this morning when Kathleen [Quirk] was talking about the various changes in the underlying cash flows at Freeport-McMoRan, you know, when she was examining the various commodity prices. Our business model is a little bit tighter than that with respect to the underlying businesses. However, when we look at currency—and foreign currency transactions represent 25% of Visa’s top line revenue—our concern is really not the volume of foreign currency we’re going to get, but how it translates back to dollars.
So what I wanted to do is just run through the solution—excuse me, the problems that we had; run through some of the challenges we had at Visa, and how the Reval solution that we brought to bear addressed that, those problems and challenges; and lastly, a little bit of the results.
So when we look at the problem statement, if we just ignore the word ‘hedge’ and we ignore the word, you know, ‘foreign exchange,’ I think what’s going to resonate with most people in the room who have got legacy systems, legacy processes, inner, you know, you’ll see that what we have here is that it could address almost any different aspect of treasury. It could be cash management; it could be liquidity investments. What we had, and what I wound up inheriting, was a situation where there was little internal focus on an existing process. As a consequence, our accounting team, with the exception of Alan Tam, who is here today, we had very little internal expertise. Quite frankly, we had outsourced FAS 133 hedge accounting to an independent third party who would wind up doing all of the hedge accounting for us; they would pass on a monthly basis the journal entries back to us, and we would post it to our GL. Highly manual, you know, it was literally so manual that when I took over the process, it was only used once per year.
As a bank association, Visa was really geared, geared its hedging activities toward its annual budgeting process. We wanted obviously something much more robust and active. We want to be an active manager of currency, and we felt that the processes that we had in place for hedge evaluation, hedge execution, and hedge accounting, really couldn’t sustain itself under either a quarterly or monthly process. It was disjointed. Visa was a combination of six or seven different siloed organizations representing various interests. It was coming together as Visa Inc. just prior to the IPO two-plus years ago. but it still had a lot of legacy processes, where we had people in Singapore, London, Miami, etc., who were actually trying to do hedge accounting and—or understand hedge accounting, I should say—and book transactions. It was extremely dependent on spreadsheets and e-mail. I know I speak for a lot of people out there, just imagine the controls over that. You know, nothing that I think we were proud of, but we were certainly very anxious to eliminate. And there was no integration. It was really a standalone process. It resided in a silo in and of itself. It was, again, little understood. It was something that we all just got through, if you will, and fairly slowly at that. And lastly, and I know we’ve talked a lot about and heard a lot this morning about transparency,. the reporting was very, very limited. Obviously if you wanted some more information, you ran a bunch of queries against an Excel database and generated information. But there was—it was very limited—to say the least.
Some of the challenges that we had in putting this solution in place -- ah, was trying to make the traditional best-of-breed or treasury management system decision. We had already embarked on a SunGard Quantum implementation. We were about a year and a half into that implementation. We were going back and forth as to the viability of using the FAS 133 hedge accounting module or bringing in a Reval, so that was clearly one of the challenges. The other challenge was the consideration, of course, of just time and money. You know, we felt there was going to be some benefit from having a treasury management software solution, having everything on the same platform. But when we started looking at various cost benefits, it soon became very obvious when we started looking at the resource constraints we had, again I think I can speak for most people in the room, when we were challenged to look for and implement a FAS 133 solution, we weren’t given any additional resources. None of the individuals I mentioned before were allowed to step out of their current day-to-day jobs. We all did this on top of everything else we normally do, as treasury professionals are wont to do and asked to do repeatedly. And lastly, we were suspect about the type of knowledge and expertise that we could get from various vendors, so we were very cautious as we were walking down the path of making the decision between Reval, SunGard, or any other solution.
So when we designed the solution, we really felt that Reval was meeting our needs best from a variety of perspectives. First and foremost, the solution, which I was familiar with back at Starbucks when I implemented Reval, was something that was really second to none. You know, the professional services team at Reval truly put their A team on the project, I’m not really sure they have a B team, but the team that they put into place did a terrific job. We now have very much of an integrated middle and back office. We’re beta testing with Peter and the team at Reval their C-bar solution to help integrate the front office, which would be, again, even a better savings going forward. The elimination of the redundant systems processes and the ability to build an internal expertise, I can’t tell you what benefits they’ve really been. When I talk about some of the results, you’ll see that it really was a dialogue changer for us being able to build that internal expertise and getting away from, well, the FAS 133 hedge accounting results are just what they are. This is what the third party gave us, this is what is coming from KPMG, etc., to having a real dialogue between treasury and accounting, and began for us to then focus on higher-value activities, which again everyone in the room hopefully can resonate to that point. And last but not least, of course, as finance treasury professionals, we felt it was the best cost-effective solution.
So when we look at the results, the project was done on time, on budget. We had a very tight timeframe. We began this in August a year ago and delivered it in four-and-a-half months. It was fully integrated all the way from an FXall execution platform through to Quantum as our cash payment platform back through Oracle as our GL. It was a fairly technical solution. We actually hedge using 10 different strategies and four different legal entities at Visa, and this solution was able to accommodate a posting all the way down to the subledger, which our accounting team loved. Clearly, we eliminated a number of manual processes.
The time savings as we outline there are really probably an understatement, when we start taking into account all of the e-mailing and back and forth we had between the regional people in Singapore, London, Miami, as well as our external third parties. We felt internally that we reduced FTE hours by two-thirds. We also eliminated this third-party hedge accounting provider as well. And the hedge accounting results were not just a series of numbers on a piece of paper anymore. With Reval, we’re able to dive in at a very detailed level, examine hedge by hedge, prospective, retrospective hedge accounting—hedge effectiveness, I should say—we’re able to look on an individual basis as to what’s driving the results, and if there’s any question, you know, we can solve it on the spot. And the last point, which was an unexpected benefit, is it’s really become a conversation changer. You know, whether we’re diving through the fabled green book or we’re just having, you know, one-on-one discussion about hedge strategy, we’re taking a much more of a react -- excuse me, a proactive approach rather than being reactive, and it’s been just a terrific project so I’m pleased that it’s been recognized and, again, thank you so much.
SEWARD:So congratulations Alan and Visa. I’d like now to present the Silver Award, and that goes to Microsoft and Joel Combs. So, Joel, congratulations.
As group manager of investments and acquisitions, Joel manages Microsoft’s strategic investment portfolio. Over the last seven years, he’s been responsible for structuring, hedging and monetizing over $10 billion worth of transactions. Additionally, Joel provides thought leadership and insights into topics including valuation, capital markets, and corporate development across a variety of treasury and finance functions. Prior to managing strategic investments, Joel worked in a variety of roles with Microsoft’s capital markets group. Joel graduated summa cum laude from the University of Washington’s Michael G. Foster School of Business. He’s a CFA and has a B.A. in business administration. So congratulations Joel and Microsoft.
JOEL COMBS: Good morning. It is my pleasure today to present Microsoft’s solution for evaluating real estate proposals around the world. Over the last 10 years, I’ve worked in Microsoft’s treasury, focusing on strategic investments and focusing exclusively, more so recently, on interacting with the business units on topics such as corporate cost of capital and discount rates for projects.
Over the last few years, Microsoft’s portfolio of owned and leased real estate has grown dramatically with opening of data centers and research facilities around the world. The real estate team now manages close to $7 billion of owned real estate plus a sizable lease portfolio in more than 100 countries.
There’d never been a formal process to look at what discount rates should be used for real estate, unlike all of our other business units. Treasury hadn’t historically always mandated that they use the corporate cost of capital, which was sometimes useful and sometimes not useful, depending on the project.
But then we would learn sometimes about subsidiaries deciding that they would choose their own discount rate and use something entirely different, and some of these sometimes included things such as what the portfolio would return, so investment returns, cost of commercial paper, cost of debt, and things like that. Luckily for Microsoft, it only led to a loss of time and effort, as the projects would eventually work their way through the appropriate approval process and the discount rates would be appropriately adjusted when it got to more senior levels.
From a textbook or theoretical perspective, Microsoft treasury believes that the discount rate should appropriately reflect the riskiness of the project, and that the cash flow should also be adjusted appropriately. Each project in geography has unique risks and, therefore, should have a unique discount rate if necessary. We also saw an uptick in subsidiaries thinking about buying their facilities as they started looking at appropriate, or looking attractive at the Microsoft corporate cost to capital, especially in emerging markets, which as we know is probably not the best rate for some of those markets.
The lack of a well-communicated process led to an inconsistently applied methodology, where treasury wasn’t always involved. Increased communication, though, between the teams worked initially, and each subsidiary request was able to be handled on a one-off basis. However, the combination of a growing portfolio and the real estate market woes led us to reevaluate the entire process. A broader, more streamlined approach needed to be created such that we could look at each project sort of as a whole, or all the projects as a whole, as opposed to each individual one. With that need, treasury partnered with the real estate group and evaluated alternative methods to create a seamless, scalable solution for country-specific discount rates.
So in discussions with some banks and some consultants, we didn’t find any ideal or consistent solutions. The banks would consistently say something different between each one of them, and nobody had the same answer. So we had to sort of set out and create what was our ideal solution. The biggest part, though, of the project ended up becoming education, as the folks in treasury were not necessarily very familiar with the real estate markets, just as the real estate folks were not very tied in with the corporate finance methodologies and terminologies. So it was a huge process for that. We worked to educate when they should reach out to us with additional questions, and when they should not use certain discount rates for different projects and really tried to educate them on looking at what the risks are in the projects when they’re different.
The real estate team worked to educate treasury what their typical projects and structures looked like so that we could evaluate the different risks and try and create a peer group, where it sort of matched that of our portfolio of properties for both owned and leased, and making sure that the risk profile of that closely matched that of our portfolio, and the geographies matched. The peers were selected and weighted primarily based on valuation. After this initial foundation between the groups, we defined some ongoing engagements, which has really become more of the key learning experience for us, is just this ongoing dialogue between the teams.
Since Microsoft has segment WACCS [weighted average cost of capital], so each business unit has their own discount rate, we decided why not create one specifically for the real estate team, given that their portfolio is nearly the same size as a lot of our business units and is as large or larger than many of the peers. Treasury has typically used historical betas, given sort of the market acceptance. However, in the recent markets, there were some challenges where the betas sometimes lost their stability with historical expectations, such as tech being somewhat lower than expected and REITS being somewhat higher than expected. So also given that we were evaluating that, we had to look at alternative solutions, and we determined that using VAR as total risk forward-looking betas ended up making the most sense in this case, as it provided a somewhat more stable solution over time. Given the highly levered nature of the business, though, they had to unlever the betas because we don’t apply any of that financial leverage when we’re doing the CAPM [capital asset pricing model] process that[C2] we then ran it through. The base rate that it sort of calculated based on all this ends up being lower than Microsoft or any of its business units, so it actually provides them a slight benefit in looking at different projects. Additionally, the base rate covers almost all projects that they look at because the peer group is pretty substantial and almost everything is in some of these larger, more developed markets. So that applies to projects where similar risk profiles to what the peer group would do or it would be reasonable for a member of the peer group to invest in.
However, for riskier markets, we had to sort of take on a further step to address that, and this is where it got a little more complex. We weren’t quite sure how to address the fact that some of the regions were highly risky, and how to sort of systematically apply for 100 countries. So we worked to create a country risk premium modifier or multiplier, and we leveraged IHS Global Insight country risk ratings. And the risk ratings, I think, were extremely relevant because they cover six key criteria: political, economic, legal, tax, operations, and security. And each one of those is extremely relevant for each real estate purchase. We considered other potential measures of risk, such as credit ratings, Treasury yields, and CDS spreads; but those weren’t always relevant, particularly to real estate market or necessarily—some of the countries didn’t have them.
One of the challenges that we looked at, though, was the IHS ratings were on a linear scale, and so we had to figure out, with 1 being the least risky and 5 being the most risky. We had to come up with the solution to sort of scale this linearly because risk traditionally doesn’t follow linear expansion, so we ended up using an exponential expansion to scale this on a relative ratio between the United States, or the foreign country and the United States. So for example, if a country’s risk rating is 50% higher than the United States, the multiplier would be two-thirds higher, and if it was twice as risky, it would be three times higher, so there was more and more penalty the riskier the country. And a lot of this started because there was one specific subsidiary that thought it was a great idea to buy their real estate and they were using a discount rate of Microsoft’s corporate cost of capital, which was then subsequently raised much higher, and so it didn’t look attractive.
While the solution is not necessarily perfect, as nothing is in the corporate finance space it seems, it is generally directionally correct. At least now we know the subsidiaries are starting to look at things at the right direction in terms of ‘Zip code,’ I guess so to speak, for the discount rates. We can further fine-tune this rate as the projects are either material or, in the case where the partner has questions surrounding the risk and whether it’s relevant to the overall corporate discount rate or specified discount rate for the real estate market. While the solution might not work for every company or every situation, the process has actually worked quite well for us. It’s been very well-received by our partners in the real estate group. It greatly improves the consistency and accuracy of the application of different rates across real estate projects, significantly reducing our risk for comparing buy-vs.-lease decisions. The process continues to be organic and should continue to evolve over time as the groups continue working together.
And with that, I’d like to conclude and say thank you for your time and thanks to Treasury & Risk for this opportunity. Thank you.
SEWARD: So, thank you very much, Joel, and congratulations to Microsoft. Finally, I’d like to present the Gold Award to Thomson Reuters, represented by David Shaw, SVP and corporate treasurer of Thomson Reuters. So congratulations, David.
David, as I said, is SVP and corporate treasurer of Thomson Reuters, where he’s responsible for the corporation’s global treasury activities including capital strategy, capital markets, rating agency communications, risk management, pension investments, and banking relationships. A nine-year veteran of Thomson and all its incarnations, David started at Thomson Corp. in 2001 as VP and assistant treasurer. In 2005, he moved to Thomson Financial as SVP of finance. In 2007, he was transferred back to Thomson Corp. as VP, corporate finance and business analysis, and he’s held his current position as SVP since April 2008. Before joining Thomson Reuters, David held various corporate finance positions in the treasurer’s office of General Motors and worked as a CPA with Price Waterhouse. David graduated from the State University of New York in Albany with a B.S. in accounting and received an M.B.A. in finance from Columbia Business School. So please welcome David.
DAVID SHAW: Well, thank you very much. Speaking for Thomson Reuters, we’re very pleased to be here and really excited about the recognition that we had for this very important project. I’d also like to thank the team that really did most of the work around this and it was really led by Michelle Scheer working extremely closely with Miranda Hall and Angela Clarke; they really made this happen. So I’m going to take a few moments and go through this project. I realize it’s always challenging being the last speaker before lunch, so hopefully you can bear with me for about 10 minutes here.
So just to set the stage and the background a little bit. Back in April 2008, Thomson acquired Reuters, and it was really a transformational acquisition for us along many, many dimensions, but one of which is, it really expanded our business geographically. Our foreign exchange exposures increased exponentially. And on this slide here, you can see about 30% of our revenues, which were now $13 billion, were outside of North America, and 35% of our cost base was also outside of North America; and unfortunately, they weren’t in the same countries, meaning we had a very large mismatch in terms of where we realized our revenues and where we incurred our expenses. So the mandate of this project was really to understand our exposure, not to just understand our exposures, but to quantify the risk of those exposures: what it meant to the corporation, and then really put a plan together in terms of how to manage those exposures.
So in terms of measuring, what we did first is develop a risk portfolio tool, really to mention -- and Peter led a great segue in, in terms of some of his earlier slides -- we called it value-at-risk, but it was really our cash flow at risk in terms of trying to understand what the exposures really meant to us. And this was a model that we built in-house, and what it really allowed us to do was to understand the exposures, the magnitude of the exposures, the differing directions of the exposures, as well as the correlations of those exposures. And so, for example, if you took sort of a stress test on individual exposures by each currency pair, we’d come up with an exposure of about $350 million to $400 million. But when we applied, sort of doing a really extensive value-at-risk analysis, we learned a tremendous amount about our exposures; although we had a very, very complex foreign exchange footprint, we were getting a lot of benefit from this complex exposure. So, for example, that $350 million to $400 million exposure reduced to about $125 million without managing it, just by understanding it. And that was one of our first big takeaways in terms of being able to quantify the exposures for the corporation, both from a free cash flow perspective as well as from a P&L perspective.
So then it comes down to how to manage these exposures. We really took a two-prong approach and first was via commercial policy. We really feel this is the optimal way to reduce the exposures, I mean, it’s the way you can permanently reduce your exposures. So I realize it’s much more easily said than done, but it’s really where you want to start, and that’s where we got very close with our commercial policy teams, and then again we used this same portfolio risk management tool to try to quantify how we can improve our footprint.
And I’ll give you a few examples. I mean we were first going down a path where we’ve always talked about maybe we should go to global U.S. pricing. We always thought that would be a very simplistic approach, but when we ran the numbers and put it through our VAR analysis, it was actually going to increase our exposures; it wasn’t going to help. It was really going to steer us down a path that was going to make it much more complex and increase the risk. And candidly by doing that analysis, it gave us a lot more credibility with the businesses and the commercial policy organizations when we could explain that to them.
So then we moved to more approaches that would really permanently improve our footprint. So for example, we have a very large euro, long euro exposure and a very short sterling exposure, so we tried to work with the commercial policy teams to see how we can increase our sterling revenue, for example. We looked at our global accounts that maybe are domiciled in the U.K. that would be open to sterling pricing and try to decrease some of our short sterling exposure. Then we worked with procurement as well in terms of seeing how we can source better still doing it economically attractive, but maybe for example, we can move more costs into the euro area where we were long. So that was our first step.
And then secondly, we moved to our hedge program in terms of how to manage the balance of the exposure that was left. And again, using our value-at-risk analysis, it really came and pointed us in a direction where if we just hedged our top three exposures -- and again, we’re in about a hundred countries, we have lot of varying risks -- we found by hedging those top three exposures we would roughly get the same risk reduction, for example, hedging eight or ten of those currency pairs. So that already created quite a bit more efficiency. Additionally, we decided that we would manage this program centrally to try to reduce the burden on the businesses as well as take advantage of the global netting of all these exposures.
Now the main objective of the hedge program really was to manage primarily our cash flow risk, but as well to reduce our P&L volatility. Given the nature of our exposures, hedge accounting was really quite challenging and it was something we decided not to pursue; but despite not going forward in the hedge accounting, we were still able to reduce our free cash flow risk by about 50% and our P&L volatility by about 30%.
So key program benefits, I sort of put four items down here. First, I’d say the organizational engagement. I mean, we really partnered with the operating -- the businesses themselves; they took accountability for their forecasts. We worked with the commercial policy team to reduce versus more permanent types of solutions. I’d say the senior management level people understand the risks, understand the impact of free cash flow, understand the impact of the P&L statement, and now understand now how we manage that risk; and then we put metrics around this that we report on a monthly basis so people really understand it.
Secondly, we have true real risk reduction. One is just by understanding our footprint and the benefits that we get from a complicated foreign exchange footprint. And then secondly on that, by putting together a hedge program to actually reduce our free cash flow risk by 50%, and we’re still able to leverage our sort of portfolio management tool as the world changes -- as we grow in Asia, for example, and as our footprint changes, we can see how we’re going to tweak this going forward.
And I’d say third, foreign exchange is no longer a business distraction. They’re focused on driving growth, driving returns, and less about short-term foreign exchange volatility. And I’d say lastly we were able to do this really at a zero cost implement. We’re able to leverage our existing people, our existing systems; we’d bring in a bank just to sort of validate what we were doing and make sure we weren’t going down a path, that ultimately we went down a path that we felt very comfortable in; we were extremely pleased with the results.
And with that I’ll just say thank you again for acknowledging what was a very important initiative for us and happy to take any questions.
SEWARD: So thank you, David, and congratulations to Thomson Reuters. So firstly, please put your hands together to congratulate Alan, Joel, and David on their submissions and their representing their companies. So I’d like to throw it open to the floor if anyone has any questions on any of the submissions?
So well, I’ll kick it off with one question, actually, and it will be great if each of the panelists could respond to it. You saw three presentations, and two in FX and one on real estate, assessing of risks. But each of them involved, you know, some technical tools not specific to finance and treasury. We had VAR, we had hedge accounting, and we had the CAPM model to evaluate discount rates, so very technical tools that each of the finalists were using. So I’d like to ask each, how did you go about -- what challenges did you have communicating to your external non-treasury stakeholders that you engaged, and all of you sounded as though you engaged them, and what strategies did you use to explain to them why you were coming up with the recommendations or the alternatives that you ended up putting in front of them and making decisions on? So David, it would be good to hear from you first.
SHAW: Sure. Well, I think for us, as we came together as one company, this foreign exchange, I’ll call issue, was really something that seemed like a bit of a black box. No one really understood the financial impact of these exposures, or if we did we spent a lot of time analyzing without sort of key ongoing takeaways. So I’d say our interaction internally was very welcome. I think that people wanted to understand, they then wanted to have a solution.
I think it really took us a while to get to it, quite honestly, just because we were integrating two companies and, you know, the first slide you saw that footprint, it took us awhile, quite a long time just to get comfortable with that footprint. And as we’d say internally, it’s tough to manage what you can’t measure, and, you know, getting to that point was a lot of heavy lifting. But I think the interaction in general was very welcomed in a sense because people wanted to get their heads around this and get their hands around it. So I think once you got to a point that you can actually quantify an amount in that impact, it becomes much easier to manage and much more accepting internally.
SEWARD: Okay, thank you. Now Joel?
COMBS: Yes, so from Microsoft’s perspective, I mean, as I sort of already talked about, education was such a huge part of it and to sort of -- to go back and forth between the teams was definitely the critical part of the project. They were very open to new ideas and to really understanding exactly what the project was and trying to understand what the discount rate was and why it should be what it is. I mean, as sort of a sales pitch for Microsoft, I mean, we obviously leverage a lot of our own internal tools to sort of distribute this information. So SharePoint Web sites and Office Live Meeting were definitely critical, because it’s not a centralized real estate team. Whereas corporate finance and treasury is definitely, for the most part, centralized, you had a very global base of folks in the real estate team from all corners of the earth. So that was definitely a critical way to sort of disseminate that information. And so far, everybody’s been extremely happy. I mean, historically there hadn’t always been a lot of clarity, and so that’s why people sometimes made up their own rates and glad that we’ve taken care of all that.
SEWARD: Thanks, Joel. Alan?
WEINDORF: At Visa, foreign currency is a daily activity. It’s part and parcel of what we do with, with, moving around, up to $5 trillion a year in various currencies. So the idea of changing from an annual process to a monthly process to hedge our own exposures in examining our top currencies, but looking for truly a straight-through processing solution, didn’t require much buy-in at all. It was really part and parcel with, or an extension, if you will, of our larger treasury management system solution. You know, we had terrific engagement throughout the finance organization, wonderful partners in accounting and financial systems to work with, so for us it really -- it didn’t require too much at all, Peter.
SEWARD: Thanks. Any questions?
Q: Very, very quickly. A question for David Shaw with the value-at-risk metric. The metric has come under a lot of criticism over the past couple of years. I’m just curious as to how often the frequency that you use value-at-risk and if you had any problems with back-testing that to see if what it said really was correct?
SHAW: That’s a great question. I mean, to start with the second one, we actually did go back in history and back-tested before we implemented, to see what the risk reduction would have been had we implemented this program, say, three years ago, and it gave us a lot of confidence that we were going down the right path. So we felt very good on that, and again it was something we wanted to do before we implemented it just to make sure we were going down the right path. I’d say we update our exposures on a quarterly basis and we -- the numbers that I show you will be a little different than in three months from now and a year from now, but directionally it’s sort of holding true. I mean, you certainly can make different assumptions in terms of the amount of history you want to use, for say volatilities and correlations, and that will impact some of the results whether you go a year, five years, whatever you choose. But I think generally it’s going to give you an answer that you’ll feel comfortable in terms of managing the program.
SEWARD: OK. So thank you very much. I believe it’s time for lunch, so please put your hands again for one final congratulations.
DUGGAN: All right, thank you so much Peter and Reval for sponsoring this session.