How auditing treasury operations can drive business value?

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Magasine du Trésorier
June 2011

Today’s challenging environment, mainly resulting from the aftermath of the financial crisis, sets up new key performance indicators for companies such as available liquidity, credit risk monitoring and cash management. The economic context remains fragile considering defaults on sovereign debt rising, credit conditions still tight despite the central banks’ efforts and high volatility on the foreign exchange market. Difficult choices lie ahead for companies that struggle to prove to their shareholders that they have what it takes to compete for growth. What are high performers getting right?

They are undoubtedly focusing on optimizing working capital requirement, managing efficiently the finance function, including treasury operations, on reducing their dependence on external funding and on using cash pooling to limit low balance and transactions fees and/or to combine several accounts into one. Therefore, it appears crucial to make a diagnosis of treasury operations and to compare it to the market’s best practices. This diagnosis should be focused on risk management exposure and on transaction life cycle from authorization to settlement.

Fiercer competition has been observed and is not likely to disappear
The market has been very difficult in the past two years and therefore more competitive as a consequence of economic slowdown with companies struggling to keep market share and to maintain a positive bottom line. As companies secure their survival, spotlights are now on growth. Competition is increasing throughout the entire value chain but the greatest challenge remains being faced in the market. It is not only about comparing growth rates between all companies anymore. Today’s market is demanding, generally oversupplied and increasingly price sensitive. From now on, companies will have to gain growth from competitors. In doing so, there will be winners and losers.

High performers have taken significant measures to stay ahead of their competitors. They realized at an early stage that treasury operations could drive business value through a 4-step-approach.

Treasury Department can play a key role in risk management
There are two essential steps in an efficient risk exposure management system. The first step consists in ensuring an adequate segregation of duties is in place within the treasury department. According to best practices, the market activities department should be organized with three independent functions – Front Office, Middle Office and Back Office – and an additional employee in charge of the reporting. To each function corresponds a set of responsibilities to guarantee segregation of duties. Typical Front Office tasks include pure treasury operations such as deposits, loans, borrowings, commercial papers, FX whereas Back Office embrace other tasks like reconciliations of cash flows, payments, deal confirmation or cash pooling. The independence of the reporting function remains crucial to perform objective profitability analysis and monitoring of financial risks. The whole framework of roles and responsibilities should be formalized by a detailed organizational chart, validated by the group CFO and communicated to whom it may concern. The second step corresponds to the review of parameters used for exposure assessment and reporting which is achieved by controlling the balances of bank accounts on a daily basis.

Segregation of duties and a list of duly authorized persons are the keys to an efficient transaction process
The focus should be set on four areas to ensure that this process is effectively covered – the use of special authorizations for specific transactions and for sensitive data, the existence of a list of authorized counterparts and relative limits, the definition and approval of accreditation and delegation procedures regarding bank account management, and an adequate segregation of duties. Prior authorizations by the Treasurer or Assistant Treasurer are required for all operations linked to specific risks and strategic covers in order to comply with the best practices. Access to sensitive data should be restricted to authorized persons – easily listed if the segregation of duties has been effectively performed – and regularly saved following a back-up process. Data regarding counterparties should only be input in the system once the reviewing of existence, creditworthiness and reputation has been performed by checking with the counterparty’s legal department. Bank accounts also represent a key risk of fraud which implies that several aspects should be monitored such as segregation of duties, including a clear list of authorized persons communicated to all internal and external counterparties. Regarding the execution of transactions, one person should not be able to initiate a deal, validate it and modify it after validation. This is where segregation of duties appears crucial.

System entries regarding deal capture and confirmation must be regularly monitored to prevent fraud
Major inherent risks to the capture process include the absence of a capture master for each nature of transaction, requiring the recording of essential information, an unrestricted access to this master, and an insufficient recorded amount of information regarding settlements’ calculation – interest calculation conventions, amortization schedule and so on. All of these should therefore be covered by adequate procedures and controls. Concerning deal confirmation, the distinction between confirmed and non-confirmed transactions must be very clear, implying a constant follow-up by the Back office of any deal entered in the system. For new or amended products, trade confirmations should be automatically generated by the system and re-confirmed as per best practices’ standards.

Settlements cut-off and accounts reconciliations are a must to ensure cash availability
Settlement is a three-step-process – payment, calculation and bank reconciliation. Any shortcoming on the monitoring of the first step would lead to a high level of fraud risk since the payment request has to be justified and approved and input of banking references in the payment system must be carefully controlled and validated. The calculation step requires the Treasury Department to anticipate on scheduled payments and repayments to perform settlement calculations in advance, to execute a scrutiny on all payments and repayments to ensure an adequate cut-off. As for bank reconciliations, a regular follow-up encompassing a reconciliation of bank accounts and investigation of differences is essential.

Conclusion
High performers have no secret magic formula but an optimized finance function with well monitored treasury operations leading to a sound risk management system and to cost reductions. Complying with the above mentioned best practices will lead to reducing funding costs and needs, decreasing working capital requirement and increased agility in the finance day-to-day operations.

By Brice Lecoustey, Senior Manager, Advisory Services, EY, Luxembourg