Financial Risk Management 2010 Transcript

From Treasury & Risk's 15th Annual Alexander Hamilton Best Practices Awards

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.

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.

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.

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.


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.


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.


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.


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.

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.


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.

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