Managing Cash Flows in Volatile Markets Tools, Techniques and Global Experience

Transcription

1 Managing Cash Flows in Volatile Markets Tools, Techniques and Global Experience 24-26

2 Agenda Backdrop Framework for Financial Risk Management The Cash Flow at Risk Model Q&A Slide 2

3 Backdrop Key structural change in the last few years: Financialisation of the real economy Dr. Y.V. Reddy 3

4 Backdrop Today s economy brings new challenges : Managing an international business in a competitive global and uncertain economic conditions; and Facing sharp volatility in currency, commodity and stock prices. These challenges are important to all businesses Slide 4

5 Backdrop What we aim to present are tools that help businesses: Understand the impact of volatility on their cash flows and earnings Embed this understanding into strategic and operational decision making to enhance business performance; and create a competitive edge. Measure and control risk exposure; and Support the development and execution of business strategy for example like hedging. Slide 5

6 The environment Benign Stand alone systems /markets get connected Global in balance of current accounts Excess liquidity in the global financial markets Increased commodity consumption Continuous growth in Western Economies achieved through consumer spending and borrowing Advent of on-line communications Emergence of crisis Sub-prime market unfolds Banking crisis (Lehman, AIG, etc.) Market and Investors overreaction Heavy government Intervention Integrated action by global monetary authorities Quantitative easing Provisional stability Emergence on alternative investment models Currency management / war Government support to private sector loss Bi-polarization of political and economic management Emerging markets orientation Political Instability The Feedback Effect Losses filtering through the system Western governments over commitment Counterproductive and clashing monetary and fiscal policy Re-entrenchment to local solutions Volatile flows in Emerging Markets Investors Overreaction More Quantitative easing The Future A co-ordinated global approach? Rebalancing between producing and consuming countries? Currency instability? Commodity price instability? Inflation / deflation? Slide 6

7 Heightened uncertainty Market volatility continues Rupee depreciation posing a risk Metal prices looking down GDP growth expectations slashed Sharp contraction in investment Moderation in corporate margins GDP Quarterly Growth Change from a year earlier India's GDP moderates as Inflation continues to soar Mar Jun Sep Dec Mar Jun 10 Sep Dec Mar-11 Jun 11 Sep Quarterly Inflation Change from a year earlier 51 FX Rates USD per MT USD INR 43 Aug-11 Sep-11 Oct-11 Nov-11 Copper 6600 Aug-11 Sep-11 Oct-11 Nov USD per MT Aluminium 2000 Aug-11 Sep-11 Oct-11 Nov-11 The market scenario continues to unfold 7

8 The Business fundamentals Any successful strategy revolves around achieving a combination of three basic fundamental goals: Given the current global economic and political scenario, corporate risk management strategies can be summarised into the following options: Income Growth Business Fundamentals o Do nothing o Planning and forecasting o Transactional : operational hedging o Active risk management Cost Control Minimisation of Variances / Volatilities of Cash Flows and Earnings Making Decisions Simple June

9 Financial Risk Management Framework Slide 9

10 Financial Risk Management Framework (1) Effective financial risk management enables management to: Develop an explicit risk appetite that informs business strategy Execute effective hedging strategies; and Maximise profits, within the scope of strategy, whilst minimising earnings volatility, maintaining sufficient liquidity and sustaining growth. Slide 10

11 Financial Risk Management Framework (2) Achieving this requires a fully integrated financial risk management framework, enabled by a cash flow at risk model (CFaR) and embedded in treasury, trading, banking and operations activities. Such a framework must explicitly take account of: The illiquidity, co-dependencies and complexity of financial risks; The business key pressures and constraints (performance, capacity, competition); and Reconcile strategic objectives with the quantification and aggregation of the risk arising, including The decomposition of exposures into specific risk factors. Slide 11

12 Financial Risk Management Framework Design Key design principles Strategy Business Objectives (including financing strategy) Treasury Objectives Treasury Design Principles The design principles guide the definition, operation and implementation of the operating model Approach Clear objectives, aligned with global business objectives. Uniform global approach. Policies cover all risks and businesses. Full segregation of duties. [Value added service centre treasury. No speculation.] Organisation and governance structure Risk management Governance arrangements Global treasury organisation Monitoring framework STANDARDS FOR THE MANAGEMENT OF KEY RISKS Policies Accounting treatments Key Processes Policy framework The key operating standards for treasury The management key operating standards take for into treasury account management the as in Tata is Steel situation, Group taking good into account the practice, as is, good practice, business the business context and the outputs of outputs the EWaRM of the CFaR model model Risk Management Hedging Systems Cash Risk managed on aggregate basis. Global limits set then subdivided. Enterprise Wide At-Risk (EWaRM) Model supports formal expression of risk appetite. EWaRM supports active risk management. Natural hedging first then use vanilla derivatives. Hedge accounting for derivatives. Minimal use of spreadsheets. Use of global Treasury Management System. Maximise pooling of cash and up streaming of cash to holding companies. Infrastructure SUPPORTING GLOBAL TREASURY INFRASTRUCTURE Payments Global / regional payment centres for commercial payments. Roles and Responsibilities Technology Reporting / Forecasting Cash Mgt and banking structures Procurement Centres Global / Regional Payment Factories Procurement Centres Seek to use set up to centralise cash and FX / commodity risk. Trading (FX, commodities, etc) Overall risk managed through allocation of capital and reserves. Value at Risk and risk sensitivity measures and limits used for monitoring. Monitoring driven by P&L instead of BS / notionals / limits. Collateral management required.

13 Cash Flow at Risk Model Slide 13

14 Using CFaR within a Financial Risk Management Framework to support decision making Updated CFaR model reconciles current risk management practices with latest market forecasts and operational data Supported by CFaR outputs, Board sets Risk Appetite and Financial Strategy CFaR Model decomposes financial risks and reconciles to strategic forecasts An integrated approach to financial risk management will reduce earnings volatility and increase the effectiveness of business strategy. Cycle 1 Cycle 2 CFaR Model measures the effectiveness of financial risk management in executing strategy Trading divisions and treasury use model outputs to support hedging decisions Impact on P&L Unhedged Market Exposure Hedged Exposure New position Hedged Exposure Forecast Earnings Time Slide 14

15 Cash Flow at Risk Model Model objectives Provide an integrated forecast of the main financial reports and to illustrate the possible market driven variations from the expected outcomes. Enable different macro-economic scenarios to be considered, what-if analysis to be performed and to furnish the risk management and strategy functions with more robust and accurate information with which to make decisions. Quantify, aggregate and decompose the risks involved in the businesses, providing the risk management function with better tools to design, implement and verify hedging/risk mitigation strategies. Identify and forecast the impact of debt and debt servicing costs in the debt ratios, allowing management to analyse the potential impact of possible capital structure strategies. Allow for enhanced articulation of risk appetite, validation of equity analyst forecasts and quantification of the impact of potential acquisitions and divestitures. Slide 15

16 CFaR: Applications Financial Planning Fine-tuning of the annual business plan. Monitoring long term cash flow requirements. Debt financing analysis. Slide 16

17 CFaR: Applications Financial Planning Fine-tuning of the annual business plan Monitoring long term cash flow requirements Debt financing analysis Business Steering Scenario planning. Risk appetite setting. Hedging strategy oversight. Strategic planning review. Slide 17

18 CFaR: Applications Financial Planning Business Steering Treasury Management Fine-tuning of the annual business plan Monitoring long term cash flow requirements Debt financing analysis Scenario planning Risk appetite setting Hedging strategy oversight Strategic planning review Computing the annual business plan. Risk exposure measurement at a granular level Risk exposure management at a granular level. Financial planning. Slide 18

19 CFaR: Model Outputs Model outputs The outputs of the CFaR model include: Full horizon analysis. Monthly risk ranking. Monthly probability distributions. Aggregate probability distributions (3 month, 6 month, 1 year, 3 year and 5 year intervals). Covenant breach heat map. Risk decomposition analysis. Risk sensitivity analysis. Financial statements expectation reports. Hedge effectiveness analysis. Slide 19

20 CFaR: Example Outputs Monthly risk ranking Risk decomposition analysis Raw Materials Procurement Rank Month Number At Risk (INR Billions) 1 Month Month Month Month Month Month Month Month Month Month Aggregate probability distributions Risk sensitivity analysis EBIT Risk Sensitivities Movement -5% -1% 0% +1% +5% Risk Factors FX Rates INR Billion GBPINR USDINR Interest Rates USDLIBOR EURLIBOR Commodities Metal price Coal price Slide 20

21 Case Study 1 Asian Shipping Company Slide 21

22 Asian Shipping Company The business issue: The company won a long-term transport contract with one of the largest Emerging Markets Oil Producers. Due to local regulation the contract, which was won through a tender process, required payments to be made exclusively in the local currency. Although the contract was fixed to the total volume of goods to be transported during a five year period, it did not determine a rigid time schedule. Market quotes from large IB s to hedge exposures would render the contract not economically viable. Slide 22

23 Asian Shipping Company Exposure to three key risks: Non-convertible currency (no liquid hedge available). Oil prices (revenue, insurance and other costs linked to the commodity). Uncertainty around the timing of cash flows (lack of direct hedge). In short, generating: High volatility Significant tail risk Slide 23

24 Asian Shipping Company Simulated Frequency A Comparison of Contractual Hedges Unhedged Structured Third Party Hedge Tailored Hedge ,000,000-50,000, ,000, ,000, ,000, ,000, Potential Cash Flow (USD) Tailoring of downside risk Slide 24

25 Asian Shipping Company The application of CFaR allowed for an optimal solution to be built through a combination of mostly vanilla financial instruments: A series of borrowings and deposit schedules in the nonconvertible currencies was agreed with a regional bank for dynamic management of the tail risk. A combination of forwards, futures and swaps were placed through a number of financial institutions Limited use of exotics: structured barrier options for risk appetite management Slide 25

26 Case Study 2 Car Leasing Company Slide 26

27 Car Leasing Company The Business Issue: Very competitive car leasing market resulting in limited margins to absorb volatility. Balloon structures (i.e. large end of term payout) popular from a commercial perspective. Car Residual Value is the main source of volatility. Financial Planning forecasts explain deviations after event. Pricing carried out on a Finance Costs plus Markup Basis Slide 27

28 Car Leasing Company The Implementation of CFaR allowed: The breakdown by risk factor and the allocation of these risk factors at a granular level to types of contracts, manufacturer and vehicle, led to transparency of the required underwriting price Artificial internal allocations of profits to centres were replaced by a clear understanding of profitability by leasing activity Treasury finance and risk management techniques were tailor made to suit each of the contracts underpinning certain manufacturers and vehicles. Slide 28

29 Car Leasing Company Practical consequences: Sharper focus on manufactures and vehicles to provide the best profit - volatility combination. Active management of the combination: Implementation of 2 cycle scheme for high preserving residual value vehicles feeding back into better commercial discounts from manufacturers Residual value risk management through use of CDS for selected manufacturers Optimisation of the finance funding structure and channelling of flows through the most desirable contracts Slide 29

30 Car Leasing Company From a business perspective: The articulation of the company strategy was clearly rationalised and communicated to all departments ensuring focus on the business objectives. Financial Planning became reliable, resulting in significant improvement on the management of external stakeholders Volatility significantly reduced and results steadily improved. Slide 30

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