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Risk management? India cuts a sorry figure
BS Reporter in Mumbai |
March 20, 2008
The first Mecklai Risk Management Survey was conducted in December 2007 jointly by Business Standard and Mecklai Financial & Commercial Services Ltd.
The companies surveyed ranged from mid-sized (Rs 250-500 crore or Rs 2.5 to Rs 5 billion) to large (over Rs 1,000 crore or Rs 10 billion) in scale, and represented a broad spectrum of industries like IT services, textiles, engineering, auto ancillaries, conglomerates, commodity producers and consumers, agro and food, pharmaceuticals, etc. Eighteen companies, five of which had sales exceeding Rs 1,000 crore, did not have a measure of the risk they carried, as a percentage of sales or costs.13 companies had independent treasuries.Five of the companies surveyed had more than four people working in Treasury (although it is unclear whether they were fully focused on treasury in all cases); nine companies had between two and four people; and the rest had less than two people running the function.Only 25 companies use their treasuries to provide budget rates for export pricing.Only 17 companies identify exposures for risk management on the date of the contract; in all other cases, it is later -- either the date of invoice or the date the exposure is reported to treasury.The majority of companies surveyed (35 out of 45) manage imports and exports separately.The vast majority of companies (38 out of 45), including 12 of the 13 with independent treasuries, had a mandatory hedging requirement; in most of the cases (25), the mandatory hedging was at or more than 50 per cent.Twenty-seven companies used only forwards as hedging instruments and nine companies used the entire gamut of instruments, including structured products.As many as 17 companies did not have a regular mark-to-market of their exposures.While 31 companies have a running ERP or one under implementation, only two companies have an operational treasury software.
Of the 45 companies that responded to the survey, 12 had a turnover of more than Rs 1,000 crore, 13 had a turnover between Rs 500-1,000 crore and 20 companies had a turnover between Rs 250-500 crore.
In a nutshell
While we recognise that 45 companies do not provide a significant sample, we note that another widely reported survey on treasury practices had only 32 respondents. Further, we have continuing contact with these and a large number of other companies on treasury matters, and we plan to use this survey as a starting point.
Updating it every year, we would expect that by Year 2, we should have a more respectable survey total of over 150 companies. Nonetheless, we believe that the findings do provide some interesting insights into the treasury practices of Indian companies, and, in particular, suggest important areas that need improvement.
Results and Analysis
We found that the average index value of our sample group of companies was 46 (out of a total possible score of 100). The best performer scored 70 on the index with eight (out of 45) companies scoring above 60. The weakest performer scored just 19 on the index and 15 other companies (a third of the sample) scored less than 40. The median score was 47.4.
This performance, while hardly edifying, is not particularly surprising since it is clear from anecdotal evidence that most Indian companies are still quite far from having good risk management processes.
Some of this may have to do with the fact that it is only recently -- say, the last four or five years -- that the forex market has started throwing up surprises in terms of two-way movements. Again, it is only recently that many companies have come to realise that they are, indeed, on their own in the global market and need to create systems that will protect them when things get rough.
Still, there were some surprising results. For instance, there was very little correlation between size and a strong treasury. Of the 12 companies in the sample that had sales in excess of Rs 1,000 crore, five scored higher than 60, while four were below 40.
Again, importance of risk also did not correlate well with better treasury processes. Of the 15 companies that (supposedly) saw forex risk as important, only three had a risk management score above 60.
Of course, these correlations -- or the lack thereof -- may merely be a function of the small size of our survey; if so, the next two surveys should resolve the issue.
Insights and Surprises:
a) Eighteen companies, five of which had sales exceeding Rs 1,000 crore, did not have a measure of the risk they carried, as a percentage of sales or costs. While measuring risk almost seems to be a contradiction in terms, we believe that companies need to have some sort of objective measure of the risk they carry, if only to be able to monitor changes that can confirm whether their risk management processes are working. One of the key adages in risk management is: If you can't measure it, you can't manage it.
Interestingly, 27 companies did have an estimate of the risk they carried with 14 of them assessing risk at greater than 5 per cent of sales.
b) Twenty-six companies -- more than half the sample size -- did not have a documented risk management policy. This is rather surprising, particularly since risk has become virtually the defining parameter of the business environment today. Again, Clause 49 of the Security and Exchange Board of India's listing agreement requires the senior officers of listed companies to sign off on their risk management processes.
Even the Reserve Bank of India's [Get Quote] guidelines do not permit banks to sell derivative products to companies that do not have documented risk management policies (although, of course, this particular guideline is more likely not to be breached).
Interestingly, only four of the 18 companies that did have risk management policies scored in the top range of the survey (over 60); five others scored above 50. This suggests that even of the companies that have recognised the need for a forex risk management policy, the majority have not been able to extend this understanding into stronger treasury operations.
c) Thirteen companies had independent treasuries. Seven of these were large companies and two were in the Rs 250-500 crore range. Oddly enough, only seven of them had documented treasury policies. Perhaps even more oddly, three of these companies did not have independent confirmation of deals by the back office, and one of these companies did have a treasury policy. This indicates that policy development, at least in this case, needs more rigour.
d) Five of the companies surveyed had more than four people working in Treasury (although it is unclear whether they were fully focused on treasury in all cases), nine companies had between two and four people and the rest had less than two people running the function. Nine companies had more than five training days a year budgeted for the treasury team, 15 had between two and five days and the rest had fewer than two days budgeted.
e) Twenty-five companies use their treasuries to provide budget rates for export pricing. This suggests a significant disconnect between the risk management process and the underlying business.
f) Only 17 companies identify exposures for risk management on the date of the contract; in all other cases, it is later � either the date of invoice or the date the exposure is reported to the treasury. This suggests that in the majority of companies, risk is identified very late in the game.
While, in some cases, it could be because contracts are for volumes and prices are fixed at the time of each order, the overall tenor of the survey suggests that this may more likely be because there isn't a sharp enough focus on risk management to recognise that risk needs to be identified at the earliest possible point in time � even as early as when the business plan for the next year is being created.
g) A majority of the companies surveyed (35 out of 45) manage imports and exports separately. Of the few that try to manage the net book, most use their EEFC accounts to minimise the cost of managing the natural hedge.
h) A vast majority of the companies (38 out of 45), including 12 of the 13 with independent treasuries, had a mandatory hedging requirement; in most of the cases (25), the mandatory hedging was at or more than 50 per cent. However, because risk identification was late [see g], this prudent measure was probably not very effective.
i) Twenty-seven companies used only forwards as hedging instruments and nine used the entire gamut of instruments, including structured products. The responses showed, however, that only four of these nine companies have documented risk management policies.
While simply having a policy doesn't ensure sound risk management [see b], the concern, particularly at this time of major unreported derivative losses, is that there may be companies who are being extremely aggressive in the market without adequate board oversight.
j) As many as 17 companies did not have a regular mark-to-market (MTM) of their exposures. Clearly, over a third of the sample was simply watching the market and not managing risk. Additionally, in 11 companies the CFO saw the MTM only fortnightly or monthly.
k) While 31 companies have a running ERP or one under implementation, only two companies have an operational treasury software. Again, this suggests a limited focus on treasury.
Methodology and index
The survey was done through an administered questionnaire, which had a mix of open-ended and close-ended questions. It contained more than 60 questions and the responses were normalised using standard procedures.
The questions were designed to assess corporate treasuries from the point of view of (1) senior management focus, (2) internal consistency of risk management processes, and (3) the sophistication of treasury operations.
There were a total of 14 questions on the issue of senior management focus, ranging from the obvious -- is the treasury policy approved by the Board, does the Board see a regular mark-to-market -- to the more complex, such as whether treasury performance is measured and how it feeds into compensation.
There were 22 questions dealing with the company's risk management processes, covering areas like definition of risk, processes for monitoring risk and processes for managing risk (transaction-wise or portfolio-wise, natural hedges, etc.). And there were 20 questions tracking the sophistication of treasury operations, which dealt with operational issues, such as the kinds of instruments used, frequency of reports, systems, etc.
There were, of course, questions that fed into more than one of these segments, and we feel that the questions combined to create a reasonably good picture of the effectiveness of the treasury function in the responding companies.
We rated companies on each of these segments on a scale of '0' to '100', and then collated the numbers in a simple average to come up with the Mecklai Risk Management Index.
While survey results can ultimately be tweaked to prove anything -- lies, damned lies, and statistics, as they say � a qualitative check of our understanding of the treasury operations of several companies against their risk management index score provided a certain amount of comfort that the index could provide a useful indicator as to the effectiveness of a company's treasury function.
As mentioned earlier, we will be continuing this survey on an annual basis, which should not only increase the number of respondents but also enable us to "see" improvements in index for certain companies and, more importantly, help us further develop the meaningfulness of the index.
We also tracked companies for scale and for importance of forex risk (through questions such as exports as a percentage of sales, imports as a percentage of costs, and interest cost as a percentage of total costs), and tried to find a correlation of the index with these parameters.