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Back in 1994, treasuries were encouraged to improve their FX programs to make the company as a whole more competitive. As we wrote in 1994:
What could help the competitiveness of US companies, at least versus the Japanese, is their FX management expertise. The ability for a US company to alter its exposure to currency movements has been greatly enhanced by US financial innovation, particularly with derivatives. However, only those companies that have devoted significant resources and management support to their treasury functions will have the sophistication to use derivatives and manage their foreign exchange risk effectively.
Back in 1994, treasuries were encouraged to improve their FX programs to make the company as a whole more competitive. As we wrote in 1994:
What could help the competitiveness of US companies, at least versus the Japanese, is their FX management expertise. The ability for a US company to alter its exposure to currency movements has been greatly enhanced by US financial innovation, particularly with derivatives. However, only those companies that have devoted significant resources and management support to their treasury functions will have the sophistication to use derivatives and manage their foreign exchange risk effectively.
Back in 1994, treasuries were encouraged to improve their FX programs to make the company as a whole more competitive. As we wrote in 1994:
What could help the competitiveness of US companies, at least versus the Japanese, is their FX management expertise. The ability for a US company to alter its exposure to currency movements has been greatly enhanced by US financial innovation, particularly with derivatives. However, only those companies that have devoted significant resources and management support to their treasury functions will have the sophistication to use derivatives and manage their foreign exchange risk effectively.
The Corporate Treasurer's Guide to Global Financial Management
june 27, 1994 Viewpoint FX Competitiveness The impact on currency rates have on national competitiveness can be enhanced or mitigated by an effective treasury function. GE Chairman jack Welch is warning against complacency on the part of the US manufac- turing sector, which is currentl y enjoyi ng the benefits of a weak doll ar (see The Wall Street journal, june 21 ). He points to j apanese com- panies aiming to compete at 90 Yen to t he doll ar by reducing costs like never before and achi eving order-of-magnitude i mprovements in performance. US compani es, he says, should be doing the same, in preparation for profits lost by a hi gher doll ar. The treasury function can help them prepare. Treasury as a US advantage? Outside of a handful of Japanese companies, the development of sophi sti cated treas ury management has been subordinated to opera- tional processes. Significant foreign exchange management losses report ed by j apanese compani es are often attributable to unsophis- ticated FX management practices- e.g. rolling over losses on forward contracts to protect operati ng profits. What could help the competitiveness of US companies, at l east versus the japanese, is their FX management experti se. The ability for a US company to alter its exposure to curren- cy movements has been greatl y enhanced by US f inancia l innovat ion, particularly wit h derivat ives. However, onl y those compani es that have devoted significant resources and management support to t heir treasury f unc- tions will have the sophi stication to use deriv- atives and manage their foreign exchange risk effectively. These compan ies wi ll be in a good position to continue to survi ve wi thout relying on achi evi ng the next quantum leap in pro- ductivity overni ght-a substanti al business risk. Such innovat ions rarely happen quickly -effective treasuries give them time. - Corporate exampl e Controlling Trading Risk at ABB By joseph Neu Distinguishing between hedging and trading is not as important when all transactions are marked-to-market and only liquid and control- lable instruments are traded. With all the news of l ate concerning corpo- rate trad ing losses invol ving derivatives, it is refreshing to see a company that understands how to profit from trading whil e controlling its inherent risks. Not involved w ith custom-tai- l ored, illiqui d transactions, Asea Brown Bover i (ABB) focuses its t radin g on liquid instruments. Dealing onl y with positions that it can unwind qui ckl y, using instruments in markets where it understands t he ri sks thor- oughl y, ABB's treasury centers earn profits with a conservat ive risk profil e. Thi s is a good exampl e for other corporates to foll ow. Control and the treasury center "To understand our internal trading controls," insists Stephan Carlqui st, Pres ident of ABB Financial Services, Inc, "you must first under- sta nd the treas ur y cente r co ncept." As President of ABB Financi al Services, Inc., Mr. Carlquist heads the US Treasury Center, one of five business areas that make up the finan- cial service segment. ABB has a hi ghl y decen- tralized organizational structure- some 1,300 operat ing compan i es wor ldwide- arranged according to a rather complex matrix of busi- ness area competencies. To support this organi zat i onal str uct ure financially, ABB developed the treasury center concept. Thirteen treasury centers around the world have been created to provide local sup- port to ABB group operati ng compani es. These treasury centers essenti all y provide arm's length, in-house banking services, such Continued on page 2 FX Competitiveness Is your treasury help- ing protect operating profits from a hi gh dollar? page 1 Controlling Trading Risk at ABB How active trading at ABB helps control financial risk. page 1 Risk Managemenrs Third Leg Time to consider adding commodity pri ces to your finan- cial risk management program. page3 Adjusting Value from Overseas Using APV analysis to evaluate overseas projects and subs. page4 Banks and Your Derivatives Use How banks can help corporates control their derivatives use. page 6 Tell them You're Reducing Risk Some advice for mid- size corporates on what to tell their bankers about FX management. page 7 IBOS Instead of SWIFT? Mul ti-bank cash man- agement and elec- tronic transaction processing becomes easier. page 8 Corporate Example Continued from page 1 as fundi ng and and f inancial ri sk man- agement, at market rates. The treasury ce nt ers thereby hel p to ac hi eve economi es of scale in f inancial activi- ties and provide ri sk miti gat ing prod- ucts and adv i ce to the independent operat ing compani es. To ensure effi- ciency, the treasury centers must com- pete with the external banks for t he operat ing companies' business. Like the external banks they com- pete with, ABB treasury centers l ook to generate profits by taking specul a- tive positions in the course of active tr ad in g. Th e tr easu r y ce nt ers are equ ipped w ith the competent staff, poli cies, and systems to ensure that trading risks are understood, measured and controll ed. " Not even the head office can enter into trading pos i - t ions/' expl ains Mr. Carlqui st, these act iviti es are delegated to the hi ghl y cont roll ed environment of the treasury centers. The elements of control Trading li ke a bank, the treasury cen- ters have developed bank-like control poli cies and systems infrast ru cture. The treasury centers employ the fol- lowing part icul arly noteworthy control elements: Marking everything to market with increasing timeliness. Al l transactions, whether intended as hedges for t he operating compani es or positions taken by the treasury center , flow through the traders and are marked-to-market according to financial policies. The reason ABB marks everything to market i s so the information on all positions is captured on a timely basis. " If you say that those kinds of transac- t ions are not marked-to-market, but these are, then you will always have some grey areas/' Mr. Car l q ui st explai ns. "We don't want to miss the opportunity to eliminate any loss-mak- ing position because we did not fi nd out about it on a timely enough basis." Time is a key performance measure for the contro l f unctio n. Risk con- trol lers interact with traders right on the trading floor. The control systems 2 are linked on-line to the traders', and the goal is continual improvement of positions valuat ion and ver i f icat i on. The controll ers have gone from mark- ing some positi ons to market every day to every second, for example. Conservative stop loss positions based on standardized, board approved risk measurement and valu- ation procedures. The amount of risk a trader takes o n any pos iti o n i s defined by the Business Area Treasury Center Accoun ting Standards (BAT- CAS). BATCAS, along with the f inan- c i al poli cies, l imit what instruments ca n be trad ed, how their ri sk is defined, what terminol ogy i s used, how risks are measured, by instrument and by risk type, and how much is acceptable for any kind of transaction. Generall y speaking, ri sk is measured according to changes in interest rates, currency spot rates, as well as interest different ials between currencies where appli cable. As all treasury centers are evaluated on thei r return on equity, ri sk is measured in terms of equity as well. BATCAS guidelines are approved by the Business Area and Segment man- agement i n add iti on to ABB world headquarters. ABB's ri sk profi le is highly conserva- tive. Treasury center financial poli cies in add iti on to credit ri sk, and legal guide I ines, compl ement BAT CAS to ensure effective risk management and control up to the most improbabl e worst-case scenari os. Comprehensive systems capabili- ties. ABB has been developing its own treasury management and trading sys- tem internally for the past 2-3 years . For t ime zone reasons, the company chose to develop two systems separate- ly, one in Europe and one in North Ame1ica. Th e two para ll el systems operate on the same C++, open rela- tional database architecture, so that both can communi cate effect i ve l y. ABB found no exter nal system t hat could match its organizational struc- ture or be made to employ its BATCAS guidelines. In add iti on to providing real-time position va luat ion and tracking, the system aims to seamlessly link f ront and back-office. Automation of admini strat i ve act iviti es- for exam- pl e, EDI co nfirmation with group cou nt erpart i es- frees time to pay attention to controls. Extreme sensitivity to credit risk. ABB limits counterpart i es to t hose with hi gh credit ratings and whenever possible ensures that counterparties at least share its AA rating. Each treasury center is charged with monitoring the credit ri sk of banks in its regi on of responsibil i ty. For exampl e, the US tr eas ury center monitors the cred it quali ty of US-based counterparties. A Lotus Notes-based system has been developed to allow each treasury cen- ter to receive a real-time evaluat ion of the entire group's exposure to any bank counterparty. Close attention to instrument liq- uidity. As active traders, the ABB trea- sury ce nt er po li c ies emphasize a trader 's ment ali ty rath er than a hedger's. A trader wants to be deali ng wi th instruments that all ow him to get in and out of positions quickly. A hedger wants an instrument that will offset hi s underlying positions- w hi ch are unlikely to change- as closely as possible. Thi s trader's bias is important in the context of derivatives. Favoring liquid- ity, ABB treasury centers use their knowl edge of treasury sec uriti es, futures, and plain vanilla swaps to construct f inanci al solutions for their operating companies without entering into compl ex, custom-t ail ored and i lli quid OTC derivatives. Asked to eva lu ate such cont racts when advising ABB operating compa- ni es, who may be offered them by competing banks, the treasury center can break them down into the under- lyings upon which they are derived. If it does not understand the ri sks of the contract in the process, the treasury center will not enter into the transac- tion- as a hedge or a trade. This is an excell ent exampl e of how trading cont rol s help reduce ABB's exposure to some of the derivatives losses experi enced by others. Internat ional Treasurer/ june 27, 1994