Digitally Enabling Risk Management Objectives: Accelerating to Smart Treasury

FX Risk Management Solutions Quarterly | Issue 127 | July 2020 | Trending 4 under a centralized treasury concept. Applying these basic components, the process for a best practice to managing financial risks becomes the following five steps: 1. Determine overall business objectives . Business objectives and factors that might influence risk management objectives include: expectations of or promises made to equity analysts in regards to financial performance, marketing and product pricing strategies, competitive position in an industry, industry trends, and business philosophy and risk preferences 2. Identify and measure risk . This involves identifying exposures based on a functional currency approach, categorizing exposures (i.e. accounting, economic), designing methodologies for quantifying the potential impact of market prices on an entity’s financial performance, and performing analysis to determine the overall risk to the company. 3. Set risk tolerances and hedge objectives . Based on the overall business objectives of the company, define how much risk the entity is willing to tolerate and the overall objectives of the hedging program. Clearly articulate these objectives in a formally approved risk management policy. Define the procedures necessary to support the risk management process. 4. Design a strategy and implement . Evaluate different hedging alternatives in terms of instrument selection and management style. The choice of strategy should be consistent with policy objectives and subject to constraints (i.e. accounting, lack of resources, and dependability of forecasts). 5. Track, measure and report performance . Determine whether risks have been reduced below approved risk tolerances. Assess the effectiveness of hedging relationships periodically as required by your applicable accounting standard. Benchmark performance against an actionable, passive, and sanctioned hedging alternative. Report hedging results to senior management. These steps define the manual process today for managing risk and applying appropriate hedging solutions based on company policy and objectives. This is a risk-based approach because the majority of the best practices rely on the quantification of risk as the basis for designing an appropriate response. However, it is impossible to respond in a timely manner to a potential risk if you are unable to measure, visualize, and quantify your risk profile on a continuous basis. This is where technology comes into play. The future of risk management best practice relies on the ability to continually, or regularly, monitor and validate the appropriate instrument selection and adjusting the risk mitigation accordingly. The table below captures some of the benefits of moving to a continuous risk management process. As part of this initiative at Citi, we expect that best-in-class treasury will transition to a continuous digital monitoring of policy to provide sufficient flexibility and built-in resilience to market disruption. Our case study (see overleaf), “Realizing Risk Management Policy Objectives” offers a good example of how some of these benefits can be realized. Table 4: Benefits expected from a continuous risk management process Benefits of deploying continuous risk management Policy objective enablement Economic output and effectiveness validation Reduction of risk without need to remedy risks such as forecast error Transparency Risk management insights and identifying opportunities in meeting policy objectives Resource and cost optimisation