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International Treasurer

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
Ame1·ica. 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