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Wednesday, 10th June 2026 |
| Offering new treasury solutions o ne treasury exposures |
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By: Paul Harris, Paul Harris
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| With corporate treasurers increasingly demanding more sophisticated risk management vehicles, banks have responded by broadening their product offerings and developing an innovative and bespoke response which mirror the needs of the companies they serve, writes Paul Harris. Some of the new risks banks are offering hedging products for include pensions risk, emissions risk, and inflation risk. |
The remit of the corporate treasurer has expanded rapidly over the last five to ten years. Previously an extension of the financial accountant’s domain, treasury risk management has developed into a discipline in its own right. | | Paul Harris |
As the parameters of risk management have expanded, it is no longer sufficient for the treasurer to consider purely vanilla foreign exchange and interest rate risk. The new paradigm for treasurers requires an all-encompassing approach which embraces all the variable elements to which the company is exposed. In a parallel development banks offering corporate treasury services have needed to respond to the increased demands on the treasury professional by broadening the product offerings and developing an innovative and bespoke response which mirror the needs of the companies they serve.
The new risk areas of treasury are many and diverse. Bank of Ireland Global Markets offers solutions-led services across a broad range of the new areas that are exercising the minds of treasurers everywhere. A number of the risks for which the bank has developed expertise are considered below.
Energy risk
It is well-documented that the costs of energy have been in an upward trend since 2002. Increased costs associated with gas, coal and oil impact the bottom line and, by extension, the ability to compete in increasingly global markets. Risk management of energy price risk has become imperative for many manufacturing and transport companies. Utilising derivative risk management tools is a strategy that is continuing to grow apace as companies seek to immunise themselves from the prevalent volatility in the energy markets.
Inflation risk
Over the past two years inflation swaps have entered the mainstream with volume growing tenfold. Companies involved in inflation-linked rental or lease agreements, pension plans and those with exposure to government or local authority contracts can employ inflation swaps to mitigate the price risks associated with inflation rates in a number of jurisdictions including Europe, UK and the US. Inflation swaps can be used to better match affected revenues and outgoings.
Property derivatives
The buoyant conditions in the European property market have given rise to rapid growth in the area of property derivatives, in particular swaps linked to commercial indices. These derivatives are structured where an investor pays a spread over interest rates in return for receiving the performance of a specific index. The prime index is the IPD (Investment Property Databank) which covers UK commercial property either in totality or on a segment basis (eg. Retail, industrial, office).
Pensions
The adoption of new accounting standards has seen many companies have their Defined Benefit pension plan surplus or deficit reflected on their balance sheet for the first time. In many cases the deficit shown on the balance sheet has had a significant impact on the company reserves and hence has had a knock-on impact on the operation of the company.
Consider the position of a company reporting year-end results. In recent years, figures have been calculated using FRS17 (standard covering pension disclosures) but were only included as a note to the accounts, and therefore, had no actual impact on the operation of the company. However, when comparing the figures shown in these notes over a number of years the volatility of these disclosures becomes clear.
In particular, it is noted that falling bond yields can cause the liabilities to increase at a faster rate than the assets, despite the asset performance over the given period.
The additional volatility introduced onto a balance sheet due to the pension plan may not be something that a company is happy with. A solution can involve the company pension plan trustees and relevant advisors examining each of the risk factors, deciding on the level of risk they are willing to adopt, and investing the assets in as efficient a manner as possible with reference to these risk factors. Some of the elements included in the solution are as follows:
• A series of interest rate and inflation swaps designed to remove much of the inherent pension plan exposure to these factors.
• The use of some alternative investments in the hedging strategy due to the explicit risk parameters adopted and the suitability of these investments to generate the required returns under the interest rate and inflation swaps.
Continued exposure of the pension plan to some equity investment (in order to allow for potential positive experience of this asset class).
The particular strategies used can vary and can be extended to many pension plans.
Emissions
Climate change economics has leapt up the corporate agenda over the last two years. The ratification of the Kyoto Protocol and the launch of the EU Emissions Trading Scheme have necessitated a closer examination by treasurers of potential liability under these initiatives. The price risks associated with emission allowances procurement have been immense in the last year and treasurers are beginning to grapple with the formulation of appropriate strategies for both the remainder of the Pilot Phase and Phase Two, which begins in 2008. The potential costs of failing to adequately plan both exposure management (micro) and abatement policies (macro) will be critical to impacted companies in the years ahead.
The new areas of risk management outlined above present the corporate treasurer with fresh and exciting challenges which push the bounds of treasury management. It is incumbent on the treasury provider to offer cohesive and specialist expertise in these new areas in order to guide the treasurer through the maze of emerging products. |
Paul Harris is head of the energy & emissions desk, in the global products team at Bank of Ireland Global Markets.
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