Chapter Twenty Four

Treasury Policy

IN THIS CHAPTER, WE RUN through the key elements of a Treasury policy. The template in Appendix A is available for download. Please refer to the “About the Website” page at the end of the book for more information.

FRAMEWORK

The Treasury policy typically is divided into the body, which contains the overall thought process and approach to Treasury management, and the annexes, which contain the specific execution aspects.

In principle, the board can approve the body of the policy and annexes, providing the Treasury management team with the flexibility to conduct Treasury activities on a regular basis with oversight by the chief financial officer.

The annexes may be reviewed every quarter to ensure synchronisation with market and business developments, and the entire policy and performance under the policy itself may be reviewed annually.

The body of the policy itself can largely be divided into these sections:

• Foundation. Contains the rationale, background and philosophy, scope, operations and control, objectives, policy approval and review, non-compliance and exception resolution, conformance with accounting policy, and code of conduct
• Roles and responsibilities. Contains the organisation structure, role or function-wise responsibilities, committees, and groups
• Transactions Management.
• Balance Sheet and Liquidity Management.
• Risk Management.
• Annexes. Risks to be managed, tenors, amounts and time horizon for risk management and investment, authorised products and arrangements, authorised signatories and limits, risk management tools such as budgeted rates, and scenarios

A sample policy can be found in Appendix A. This pro forma document can be taken and amended by readers to suit their needs.

ASPECTS OF POLICY IMPLEMENTATION THAT NEED CLOSER SCRUTINY

Some aspects of Treasury policy require a closer look.

Exception Handling

Exceptions occur as a way of life, the larger the Treasury is. The policy must contain, elements of exception handling with resolution and escalation methodology, levels, and tracking. Every exception must be reviewed, and confirmation that this type of exception has already been included in the policy must be obtained. To start with, a policy cannot include every kind of exception. Hence, the Treasurer must ensure that, apart from correcting the root cause of the problem, the policy itself includes the new exception or issue type and its resolution during the next review.

Being Close to the Market

It is not very easy to run risk management or a balance sheet by doing periodic market monitoring. It is the job of a Treasurer to be close to the market, to understand dynamics and market moves, and also to be prepared to take immediate action should there be suitable market opportunities or adverse market moves. Hence, access to market information systems, such as Reuters Eikon, that provide market dynamics and regular news updates through various media, is an almost indispensable weapon in a Treasurer’s arsenal.

Competition Strategy

What competition does in their Treasuries is an important parameter in framing policy and approaches. The Treasurer can choose to follow a contra-industry strategy if the firm or Treasury has a leadership position. Many Treasurers, especially in growing firms, choose to look at market best practices and industry dynamics prior to confirming the approach.

Choosing the Right Products

The right products to hedge are critical. Sometimes the company chooses to utilise hedging products that may not be the most appropriate in the context of the firm.

REVIEW

The review element is extremely important to the successful implementation of a Treasury.

Review of Limits and Utilisation

Review of limits and the utilisation of these limits are important. Limits are maximum (or minimum) levels of exposure for market factors. These may include, for example, not more than USD 100 million of investment in money market funds, not less than 10% of spare cash to be retained in EUR, not more than 70% of JPY exposure to be hedged, and not more than USD 25 million of WTI crude oil exposure for the first year to remain unhedged. While a limit excess is not good and has to be corrected immediately, regular limit breaches have to reviewed in the context of both operational or trader discipline as well as from the point of view of limit adequacy. Similarly, having large unutilised limits has to bring about a review of the need for having high limits in that particular market factor. Limits can also be for counterparties (investments or deposits) and for authorised personnel.

Success and Failure of the Policy

Often, boards and chief executive officers assume that Treasury decisions or policies that have generated profits soon after implementation are great ones, while losses incurred shortly after policy implementation cast a poor shadow on the same policy. The thought process has to be reinforced.

Linkages with Company’s Business Plan

The Treasury policy, from all aspects of growth, cash flow, funding, investment, and risk management, has to be closely aligned with the business plan of the firm. Well-managed firms have more visibility on their business plans and prospects. They involve the Treasurer at the outset for his or her views on the plans and to be prepared for balance sheet, risk, or other implementational requirements for implementation of business decisions and strategies. A simple case in point is a large U.S. industrial corporation looking to enter southern Africa as a market. The Treasurer has to start working closely with the business leaders to put in place the financial infrastructure for payments, collections, funding, and currency by the time the business hits the ground.

IMPLEMENTATIONAL ASPECTS

This section discusses some of the implementational aspects of the policy that tend to be overlooked and underestimated during policy creation.

Dealer-wise Limits

Assigning appropriate dealer-wise transaction limits for market-related transactions is a heuristic process and an aspect in which the firm will find equilibrium over time. Aspects of these limits come from frequency of dealer usage, situations expected where such limits may be required without delaying the decision making, increased empowerment, and frequent breach of dealer-wise limits.

Time Taken Between Finding the Right Price and Decision Making

Sometimes large levels of transactions require senior approvals, and seniors may not be immediately available, due to frequent travel and meetings or conferences. In these cases, and with large pending transactions, it may be more appropriate to have preapprovals of target levels or ranges where authorisation may be provided on a case-to-case basis. Markets are unlikely to wait for chief financial officers to return from meetings.

Maker-Checker

Especially for entries in the back end, it is important to have a maker and authoriser for each entry. Irrespective of the size of the entry, unless automated, entries have to be passed and approved by separate officers. Instruments, disbursements, account transfers, and the like should also be done by two people to ensure a level of control. In some cases, on materiality, thresholds may be set below which such approvals may not be required.

Independent Back Office

Independence of the back office, especially when the Treasurer is an active transactor, is critical from a control perspective. Also, the middle-office reporting has to be independent from both front and back offices.

Confirmations with Banks

Confirmations with banks have to made by employees independent of transaction booking.

Transfer Pricing Mechanism

Treasury must agree with business as to the price at which funds and market transactions get transferred to the business.

SUMMARY

The Treasury policy, while being an overarching document, must find the balance between a comprehensive document and a practical one. In many cases, large corporations tend to oversimplify their processes and policy and emerge with a document that is light but inadequate. Conversely, smaller companies sometimes get saddled with onerous amounts of documentation that are very unwieldy and hence difficult to implement. As a result, processes begin to lapse over time.