Borrowers: How they do it

ABB seeks exotic knowledge

Because ABB's treasury also does proprietary trading it needs a good risk-management system, says Jan Roxendal, president of ABB Financial Services. But rather than value-at-risk numbers it prefers to look at a "worst-case scenario", Roxendal says. ABB simulates interest rate movements of 1% and exchange rate movements of 2.5% to 5%, depending on the currency, and puts a number on the total risk. Having looked at JP Morgan's RiskMetrics "we found that maybe we're more conservative in calculating risk," says Roxendal. "But when it comes to calculating the return on the risk, RiskMetrics is more accurate."

ABB Financial Services is wary of exotic products, preferring liquid instruments such as fras, futures, plain vanilla swaps and options. It writes options to some extent. "But we have engaged in exotic options," says Roxendal. "It's important to have the knowledge." For example, to hedge foreign exchange exposure during the tender phase of a project, a tailored option can be useful. "We try to make sure the group is protected on each transaction," says Roxendal.

ABB's philosophy is that "we always try to have a [market] view," says Roxendal. "It's easier to accept financial exposure created by a commercial transaction if it matches your view on the market. If it does not, you have to do your utmost to hedge the exposure."

ABB Financial Services is quite decentralized, with 13 treasury centres worldwide that trade foreign exchange and interest rate risk within strict limits. The centres compete with outside suppliers for business from ABB units. "The responsibility for hedging lies with the commercial manager, and the only speculation allowed is within our treasury centres," says Roxendal. Of the 300 employees of ABB Financial Services, around half have jobs related to controlling the operation and only 100 are in the front office. "We have a lot of instrument guidelines and we stick to Group of Thirty benchmarking," says Roxendal. "I wouldn't say we comply 100% but we're close."

Electrolux wary of risk models

Electrolux is developing a system that will give it up-to-date value-at-risk (VAR) figures, with the help of Stockholm-based Trema Treasury Management. "We are a profit centre," says deputy group treasurer Gösta Bonde, "and we use second generation derivatives for hedging, in a strictly controlled manner. When it comes to proprietary trading we are very careful. We only trade in instruments that are marketable."

The operation is split into two units: the trading unit, and the unit that hedges the commercial flows. "We measure the result of everything we do. We're a kind of in-house bank."

Bonde defends the trading ctivity as taking responsibility for market risk that the company is exposed to: "Some companies have absolute hedging rules which mean they have no responsibility. But if you know more accurately what is your risk, eg through value-at-risk, management can say: 'This is what we must cover, this is what we can live with'." Electrolux treasury operates under strict limits and especially in its ratio of fixed to floating debt.

Bonde mistrusts mathematical models as the arbiter of risk positions. "The world as a whole is changing quickly, " he says. "If you try to put all parameters in your model you may come up with the wrong risks. The human mind is more flexible than models."

Electrolux is selective about its counterparties. "In 1990 [the Swedish banking crisis] we learned all about credit risk," says Bonde. But following rating agency guidelines is a sophisticated enough measure for the credit risk on derivatives, he says.

Elf keeps a watch on exotics

Elf Aquitaine's new head of financial market operations, Jean-Noël Alba, is "working towards managing the entire group's foreign exchange risk as well as its interest rate exposure," he says. "It's clear we need a more sophisticated way of evaluating risk, and I hope before long we'll have a system." Elf has traditionally been decentralized, with its healthcare and chemicals subsidiaries managing their finances separately, within a framework defined by the general management. Its financial risks and oil-price risks are handled by different teams. "So far that has worked pretty well," says Alba. "But we want to increase the accuracy of our global interest rate and foreign exchange exposure management."

Like many French treasuries, Elf has been quite adventurous in using custom-made derivatives. For example it has taken on differential swaps, paying a Deutschmark Libor rate in French francs "to hedge our interest rate exposure," says Alba. The rationale for this is that the most likely shock to hit the Deutschmark/French franc relationship is a devaluation of the French franc and a rise in French interest rates. The quanto swap is a form a protection, if you view this outcome as a danger.

"If you use only plain vanilla products," says Denis Daumal, head of foreign exchange activities, "you lose part of the information of the market. Products such as knock-in and knock-out options are secure products these days, with a lot of market-makers."

Says Alba: "We can have every type of product on our books as long as we know what the risks are." Elf has a very cautious valuation policy. "When we mark to market," says Alba, "we always mark at the worst case - the close-out price - so our [final] results are always better than the mark to market."

All-in approach for Siemens

"We're trying to develop a comprehensive framework for risk management in the company," says Edgar Wittmann, head of corporate risk management at Siemens, the German electronics and engineering group. "I'm setting up a group so that we can start on October 1." That is the same date as Siemens intends to create an in-house bank, Siemens Financial Services (SFS), combining corporate treasury and project and trade finance.

Wittmann's separate risk-management department will address not just financial risk but business risk - "all kinds of risk that could affect our results". But "corporate risk management won't actively take and manage risk," says Wittmann. It will be more a function of "locating risks throughout the company and helping develop and oversee guidelines for their management".