When treasurers and finance executives contemplate the task of managing organizational risks, there are aspects that they can affect and influence but there are also key players that are outside of their direct control. By understanding these impacts and the interrelationships between all the players, it may be possible to obtain insights to better manage financial risk.
While there are many players, they can be grouped and limited to six—those that manage, trade, advise, report, regulate and study financial risks.
Managers include corporate treasurers and investment fund managers (hedging risks). They manage financial risks by using internal natural or market-based solutions and techniques. Key objectives are to protect and/or enhance the value of the enterprise or investments by addressing financial risks related to revenue, costs, assets, liabilities and cash flows. Though they generally favor lower volatility, they can either add to or lessen volatility depending on market conditions and the state of their own financial risk book by adding or withdrawing transaction volumes.
Traders include proprietary dealers, market makers, investors and investment fund managers (trading risks). They engage with financial and associated markets, with the objective of generating profits from trading financial risks in all their forms. They generally favor higher volatility as it presents more opportunities for profitable trading. They can both add to and lessen volatility depending on market conditions and the state of their own financial risk book by adding to a risk trend (bull or bear market) on the one hand and on the other taking a counterview which may provide profitable opportunities but in so doing dampening a trend.
Advisors include financial institutions, fintech companies, consultants and economists. Their role is to provide financial risk management advice, products and services to assist risk managers. This covers all manner of financial and associated markets and instruments both in primary and secondary markets, and in physical and derivative markets. They generally favor higher volatility, as it is likely to encourage more demand for their services. They are also likely to add to volatility as they seek to recommend clients add transactions to the financial markets.
Reporters inform the community (general, business, government and professional) about relevant events and their implications, which will generate readership/viewers/listeners, influence, notoriety and ideally revenues and profits. They generally favor higher volatility as it attracts more headlines and interest, and they generally add to volatility by reinforcing trends. However, they can also present counter views that can cause market movements in the opposite direction.
Regulators Oversee the financial markets and its participants, promoting efficiency, stability, transparency and fairness. They generally favor lower volatility—or more specifically, stability—to promote confidence in markets and their operations. They generally lessen or try to lessen volatility however they can, depending on the nature of regulations imposed. Nevertheless, they can unintentionally heighten volatility by blocking or slowing natural market forces which can counterbalance volatile conditions.
Studiers, which include tertiary education institutions, academic and private industry research centers, analyze and review financial markets and the economy and how participants operate. Their goal is to test hypotheses and identify cause and effect relationships that can guide risk players as they operate. They tend to have a neutral bias but may be inclined to see more volatility, which may attract more interest on certain topic areas and thus funding for research. They generally lessen volatility by identifying insights and explanations for market behaviors and functioning, which can lead to more understanding and confidence in markets.
Lessons for treasurers
- Seek out internal natural hedges where you can.
- Seek out advice that critically tests prevailing views.
- Choose hedging techniques with low exit costs if volatility proves transitory.
- Actively shop around to get the best and most cost-effective hedging advice—if advisors are on a similar risk wavelength, they are likely to be in an aggressive competitive posture, which should advantage treasurers.
- Lobby regulators to take into account actions that can quicken market normalization or recovery.
- Promote treasury industry associations to partner with studiers to review risk management and markets to help association members better understand and deal with financial risks.
- Have a more nuanced view of financial risk management given the biases posited above, and educate management to understand these nuances and how that shapes the advice and actions of the treasurer.
- Critically ask if the risks they see are based in solid fact or more market sentiment, bearing in mind these may be in fact one in the same and so not easily distinguishable.
Fulvio Barbuio is Head Corporate Treasury & Risk, Australian Broadcasting Corporation. The opinions of the author are his own and do not represent those of the Australian Broadcasting Corporation.