Procurement collaboration mitigates treasury commodity risk
The volatility of the commodities market is propelling treasurers to assume a greater involvement in monitoring price fluctuations while working more closely with procurement teams than ever before.
The ascendancy of corporate treasurers to the very heart of corporates’ business strategy continues apace as fluctuating commodity prices have resulted in treasurers working more closely with procurement teams.
Branko Ilic, treasury and commodities business consultant at OpenLink, says: “It is part of the reach for centralization, seeing treasury merging with different functions. The treasurer is part of the process now, with a seat at the table, and are participating in decision-making process. They are in a position to be able to evaluate risk and present the options available.”
Branko Ilic, OpenLink
It is likely that the two departments (treasury and procurement) are already working together, but commodity price changes are deepening the conversation. Sander van Tol, partner at Zanders, says: “As a best-in-class approach we see the treasurer responsible for managing the commodity-price risk. This can be achieved by full cooperation between treasury and procurement. This cooperation is already there for working capital management and counterparty credit risk on large suppliers. Procurement should still be responsible for all other aspects around commodity procurement.”
Ilic says there is a lack of understanding within some business on how exposed they are to changing commodity prices: “Corporates are not always aware of how commodity intensive their business is,” he says. “Often this risk is not being managed efficiently. Companies can be vulnerable to the changing commodity price risk. The amount of risk each client has is highly variable. Through greater collaboration they are able to find the rates and exposures that work in their favour.”
Van Tol says: “Treasurers should be involved in the procurement process as they can quantify the possible impact of changing commodity prices on the company in terms of cashflows and P&L effects. Furthermore they can assist in hedging the commodity price risk in the financial markets using derivatives or assist in mitigating the risk by defining pass-through clauses for end markets.”
Despite the potential gains, Deloitte’s Global Corporate Treasury Survey 2015 demonstrated that many treasurers are unlikely to be spending much time worrying about commodity-price changes. The survey found commodity-price risk management tools were the least used on ERP systems, accounting for only 7% of utilized system functionality.
A more hands on approach to commodities by corporates is becoming a necessity as the makeup of the market changes, a transformation that might leave treasurers without the advisory base they might have previously depended on. Ilic says: “With banks pulling out of commodities we’re seeing the corporates needing to become savvier themselves. The banks moving out of the market has created new opportunities for different players and brokers to move in. When there has been a change in the service provider it has meant the corporates need to find a new way of running their business.”
Peter Seward, vice-president of product strategy at Reval, says the commodity-price changes affect multiple areas that treasurers will have to factor in to their cash planning.
“Volatility in commodities creates uncertainty in risks across the board – not just in commodity prices,” says Seward. “FX risk, for example, is often associated with commodity volatility, so there can be an impact on how treasurers manage their FX risk as well. Overall, the correlations between commodity-price risk and other risks can flow directly to greater variability in corporate earnings. A worst-case scenario can be worse than previously expected.”
A more detailed dialogue might also stop the procurement teams from taking too many risks, given volatile FX and commodity
Sander van Tol,Zanders
prices. Van Tol says: “Based on our experience we see that some procurement departments are taking bets and views on commodity prices and use more proprietary trading like hedging techniques, and stop-loss trading. We would classify this as more adventurous hedging and is most of the time not in line with the more prudent approach treasurers use for hedging FX, interest or financial counterparty risk.”
The benefits of greater collaboration between treasury and procurement are two-way. As Seward notes, the overview treasurers have of the whole business can better inform the operations of the procurement team: “Typically, procurement is focused only on commodity hedging, but because treasury is aware of all financial risks and can quantify volatility and the correlations between commodity-price risk and other exposures, procurement can better appreciate the impacts their decisions may have on corporate earnings, not just on hedging.
“A better understanding of the context can lead to more effective hedge policies. For example, despite the volatility in FX and commodities over the past 18 months, changes in correlations that offset the impacts of that volatility would have a net effect of no increase in risk, eliminating the need to make a change in policy, which otherwise would have been made based on incomplete analysis.”
Corporate treasurers are increasingly capturing the attention of the C-suite, given the increasing importance of cash management – as well as liquidity and policy planning – in delivering business goals. With regulation assuming ever-more importance, treasurers need to ensure business operations comply, as well as the banking relationship. Their closer collaboration with the M&A teams has also helped with attaining necessary financing.