Cash Management

Value at Risk

Profit-center treasuries are back, but not in the way you might think.
Ben McLannahanNovember 10, 2005

In normal circumstances, shutting down a consistently money-spinning division might cause the odd eyebrow to be raised in the boardroom or among investors. But these weren’t normal circumstances. In spring 2002, ABB was in deep trouble. The Swiss-Swedish power giant’s total debt of €9 billion ($11 billion) exceeded its market value of around $9.6 billion. The firm was facing a liquidity crunch, and potentially huge liabilities from asbestos lawsuits in the United States.

Little wonder that new CFO Peter Voser, along with CEO and chairman Jürgen Dormann, wanted the firm to “drive down the risk profile,” recounts Alfred Storck, head of corporate finance and taxes, and deputy CFO.

That meant the break-up and sale of parts of the financial services arm — and a complete turnaround for the firm’s profit-center treasury. Since the merger that created ABB in 1988, the treasury had been run as an in-house dealing room, trading in foreign exchange, interest rate and credit swaps, commodities, emerging markets and energy, and actively recruiting employees from the banking community to do so. Of a total treasury staff of 229 in 13 locations worldwide, around 40 were traders, racking up a notional daily trading volume of between $3 billion and $5 billion.

The treasury had turned a profit year on year, but that counted for nothing: amid talk of a downgrade of ABB’s debt to junk status, Voser and Dormann could no longer stomach the potential for losses. In June 2002, in the wake of a plan to refocus the business on the “twin pillars” of power technology and automation technology, the decision was taken to halt proprietary trading, and to transform treasury top to bottom. In the three years since, it’s morphed from a sprawling, risk-taking profit center to a centralized, risk-averse, service-oriented corporate treasury. ABB’s group treasury operations (GTO) is now in three standalone locations — Zurich, Singapore and Norwalk, Connecticut — with just 49 staff.

Says Storck: “You have to decide where to focus, and where to compete. We couldn’t afford any longer to have treasury as a profit center, with third-party contracts, as if we were competing with the smaller banks. Top management knew what the results were, but also what the risks were.”

Profits of Doom

ABB’s was a classic example of a corporate relic — go-go profit-center treasury operations. They started springing up some 30 years ago when multinationals, aware of their increased need to hedge while wanting to reduce transactions costs and tighten spreads, began raiding talent in dealer communities. Allocated heady sums of capital every year, these new treasury operations had the authority to trade financial instruments in the same way a bank would — provided they could demonstrate appropriate returns. The income generated from running countless open positions was typically under close and detailed monitoring, but integration with the rest of a company was minimal. It worked, for a while at least. “Some aggressive corporates used to make more money through treasury trading than through their underlying results,” recalls Inès de Dinechin, head of fixed income and derivatives sales for corporates at SG CIB in Paris.

These days, however, profit-center treasuries are thin on the ground. Many of them hit the skids after currency crises in the 1980s and 1990s, when trades famously turned sour for a string of companies including Volkswagen, Metalgesellschaft, Procter & Gamble and Ashanti Goldfields. Since then, corporate appetite for proprietary trading has waned; in the main, executives have allocated capital to core businesses over even the best-run and most profitable treasury operations.

What’s more, experts reckon that profit-center treasuries won’t make a comeback: not even now, when many companies are cash-rich, and when historically low interest rates are spurring the chase for higher returns. “It doesn’t matter if balance sheets are strong again or not, speculation has become a dirty word for corporates,” says Martin Schneider, a partner at Zurich-based treasury consultancy Tomato.

Today, at least 90 percent of corporate treasuries in Europe are run as departmental cost centers with neither profit targets nor a capital allocation, reckons François Masquelier, head of treasury and corporate finance at RTL, the €4.9 billion ($6 billion) pan-European broadcaster owned by German giant Bertelsmann, and former chairman of EACT, the European Association of Corporate Treasurers. “Most treasuries have realized they’re not there to make money, but to protect the assets of the company, and make sure risks are properly addressed,” he says.

But this is where a new understanding of “profit center” is emerging. Thanks to the likes of Sarbanes-Oxley in the United States, the LSF in France, and KonTraG in Germany, executives have been obliged to lay down guidelines, processes and controls to ensure that all activities within a company — treasury included — are carried out in accordance with the company’s objectives.

Combined with the advent of IFRS, that’s led to a new trend: the close monitoring of treasury operations. In many cases for the first time, treasuries have been obliged to report on the mark-to-market value of their positions, along with a whole host of risk exposures — “essentially, as if they were run on a profit-center basis,” says Martin O’Donovan, technical officer at the U.K.’s Association of Corporate Treasurers (ACT).

The transformation of ABB’s treasury is a good illustration of this shift in terminology. In the past, “a profit-center treasury was often one that speculated, and left positions open,” notes Robert de Gidlow, London-based treasury consultant for JP Morgan Treasury Services, and a former treasurer at both Hertz and Reebok. “These days, it means companies expect treasuries to add value, and to do so in a very proper, measured way.”

Adding value has been Masquelier’s mission for a while. A former banker at Sakura Bank and ABN Amro in Brussels, he joined Luxembourg-based CLT-UFA in 1997, three years before the merger with London’s Pearson Television that created RTL.

Since the firm listed in London, Brussels and Luxembourg in 2000, the treasury has adopted what Masquelier calls “a customer/supplier relationship” with RTL group companies.

Screen Testing

When it comes to evaluating the performance of that relationship, however, there’s no single metric: it’s more of a basket of “qualitative and quantitative” assessments. In monthly reports to CFO Thomas Rabe, for example, Masquelier presents his costs of cash management, the net hedging and interest expenses (along with updates on sensitivity to interest rate movements and the fixed:floating debt mix), the tax savings generated and the amounts of cash pooled. There’s also a tally of savings made for the company by providing intragroup services — money market, forex transactions, issuing guarantees and so on — cheaper than external banks. “By acting like a bank, you can generate margins like a bank. It’s profit, but not speculative profit,” he notes.

Added to that are regular reports from FXall (a multibank portal) and the firm’s own treasury management system on the amount of business conducted with each bank, along with details of the frequency and type of competitive bids. There are margins to be made in banking relationships too, he adds: “We try to ensure that we place business with banks according to the amount of credit they provide us with.”

The contribution to the bottom line doesn’t stop there, however. Masquelier’s seven-member treasury team — four of whom are former bankers — is also getting involved earlier and earlier in the M&A process, helping to carry out risk assessments and structure appropriate financings, especially in emerging markets. The way Masquelier sees it, he’s “an integration facilitator,” and costs a lot less than external experts.

That’s come in handy, because M&A has certainly been on the agenda at the firm, which now has interests in 31 television channels and 33 radio stations around the world. A case in point was RTL’s acquisition in July of a 30 percent stake in REN TV, a major Russian television broadcasting and production group — one of only a handful of acquisitions by foreign companies in the Russian media sector. Here, executives were particularly keen to get advice on translation risk, or the likely impact of ruble-denominated assets on both the P&L and balance sheet. “Who’s best placed to advise on financial risks? We are.”

Since doing away with proprietary trading, ABB’s treasury, too, has instilled “a service-oriented ethos,” says John Krum, head of GTO, who joined ABB Financial Services in 1991 from a money markets desk at UBS in Zurich.

Power Regulator

And like at RTL, these days, activities at the GTO are subject to rigorous oversight at board level, by the finance and audit committee. Three key policies are reviewed every quarter: treasury policy (including appetite for hedging and commodity trading), credit risk policy and compliance management. Storck says the GTO is measured with a string of targets including risk levels, cost-efficiency of cash pooling, returns on invested cash and its purchase of hedging solutions.

This kind of discipline is still far from universal, though. Among 50 respondents to a new ACT/Ernst & Young survey released this month, for example, only 57 percent of treasuries said they currently measure their performance. That’s better than the 44 percent and 35 percent reported in previous years, but still leaves room for improvement. In a similar survey carried out in 2004 by PricewaterhouseCoopers and VDT, the German treasurers’ association, just 28 percent of respondents said they included performance measurement in their reporting.

These proportions may be on the increase as companies bed down IFRS — or more specifically, IAS 32 and 39. Now that derivative transactions have been brought onto corporate balance sheets at fair value with all changes in fair value going direct to the P&L, treasurers “will be required to explain any volatility arising,” says Olivier Brissaud, general manager of Volkswagen Group Services in Brussels, and secretary of the International Group of Treasury Associations. That’ll lead to “an even greater sense of accountability,” he notes.

That’s all for the good, as far as Masquelier is concerned. It’s high time, he says, that “treasurers came down from their ivory tower and emerged from the isolation that wrongly confined them.”

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