Borrowers: Company-at-risk

Edgar Wittmann, head of corporate risk management has the title at Siemens, the German electronics group, and is setting up an independent division "to provide risk awareness throughout the company". It will operate outside the corporate treasury and won't hedge or manage risks itself.

Corporate treasurers, their bankers and advisers are talking increasingly of a broadening of the corporate treasury's, or finance department's, role into a centre of risk-management expertise on which the entire company and its decision-makers can draw. Will the chief financial officer or chief risk manager of today end up running the company of tomorrow? Unlikely, say most of them modestly.

The concept of firm-wide risk management, well established in banks, is percolating the corporate sector. But it's only partly the same discipline. Banks trade to optimize capital use. Companies use financial instruments to minimize their commercial risk. Banks can quickly change their risk profile according to their appetite. Companies have an underlying exposure - business risk - that they cannot change quickly, although they can tune it at the edges.

But banks and companies have many comparable risks - foreign exchange, interest rate, commodity, credit. Banks are ahead in the game of quantifying and correlating these risks. Companies can adapt banks' risk analysis. But they must do it warily. The danger is that the analysis gets misapplied.

"If you look at your risk too mathematically," warns Gösta Bonde, deputy group treasurer at Electrolux, "you might be getting away from reality. The world changes."

There are some corporate risks which cannot, and perhaps never will, be quantified. But many companies are adapting the value-at-risk (VAR) concept to give them a snapshot of what their financial positions might gain or lose over the next day, week or year. Few find the VAR measure satisfactory, except companies which run virtually an in-house bank which trades for profit. And even they are more interested in what VAR doesn't explore - a stress test, or simulations of a worst-case event.

JP Morgan, one of the market leaders in risk analysis, is adapting its RiskMetrics volatility and correlation toolbox, very popular with banks, for corporate use. It sells a PC-based risk-reporting and analysis tool, called FourFifteen, which can be used with RiskMetrics.

"In our next version," says Guy Coughlan, head of risk-management products at JP Morgan in London, "we're building in a corporate cashflow-at-risk capability." This version of FourFifteen will allow users to do historical and Monte Carlo simulations and stress test the company's risk positions. (Monte Carlo means the use of casino-like random-number generation to calculate thousands or millions of possible outcomes for a number of variables, from a given starting position.)

The cashflow-at-risk concept addresses the problem that many of a company's financial positions, unlike those of banks, are taken to offset an expected commercial cashflow. Bank-type VAR models typically match and correlate only tradable financial instruments.

Rallying to Monte Carlo

Bankers Trust's risk-management advisory group frequently finds that Monte Carlo simulation techniques are well suited to stress-testing and forecasting corporate cashflows. VAR, which is based on variance/co-variance observed in historical data, is useful more as a snapshot, and to get companies thinking in terms of risk management.

"A static VAR calculation is often a very good interim step," argues Marc Lopresto, who heads Bankers Trust's risk-management advisory group in London. "We've always had a greater emphasis on cashflow at risk," he says, "and a strong preference for a Monte Carlo simulation approach for modelling risk."

A Monte Carlo approach can be more robust and flexible in incorporating risks which are not purely financial in nature, says Lopresto. And it can calculate in present-value terms the potential for loss over a short time-horizon.

But JP Morgan's FourFifteen, and other desktop VAR models, don't pretend to be a replacement for a firm-wide data collection and processing system which tracks all front-, mid- and back-office information and gives the risk manager a comprehensive picture of the firm's cashflow risks.

FourFifteen should allow the company's risk manager reasonably cheaply to "play around with figures" and answer the question "what is my biggest [financial] risk", says Coughlan. "It doesn't require a huge database and real-time feeds," he says. The value of VAR, says Richard Raeburn, partner for corporate treasury consulting at KPMG, is in "helping senior management to understand the financial risk run by the company, and to know what is the significance of the open position they're allowing their treasury to manage".

Big integrated risk-management systems tend to lack flexibility, says Coughlan, and it's difficult to add new tools to them. "Every six months we're adding new tools [to FourFifteen]," he says. But for a complex corporation which wants to track all its risks, clearly FourFifteen and other VAR measures aren't enough.

Most major companies, having bought various off-the-shelf risk management tools in the past, are now spending time and money on buying or developing an integrated front- and back-office risk-management system. Again, the banks are ahead on this, having learned the virtue of tracking all their risks from the time the transaction is done to the final audit. "The market has changed from a Robinson Crusoe-type environment, clamping systems together, to the possibility of linking in all information flows," says Anders Dankar, director of sales at Trema Treasury Management in Stockholm. Nick Mitsos, managing director at Financial Sciences Corporation, New York, agrees: "Treasuries are moving away from Balkan systems to enterprise-wide solutions." Increasingly secure use of the Internet and the reduction of software costs have made real-time, group-wide data-gathering a feasible goal, says Mitsos, although he knows of no company that has this, yet.

Enterprise-wide solutions

Of course Dankar and Mitsos are talking their own book - Trema and Financial Sciences are among the risk-management software firms offering "enterprise-wide" solutions to corporate customers.

But the fashion is catching on. Trema numbers Electrolux, Volvo, ABB, Novartis, British Aerospace and Ericsson among its clients. Unilever is looking at its services. Companies see an advantage in choosing a software provider with a track record. There is also some comfort in sharing experiences with a user group.