UK: Treasury Operational Risk - Are The Controls In Check?

Originally published in February 2007

Financial scandals have been highlighted in the media to great effect. No-one wants to be the next headline.

Legislators and financial authorities have created a raft of standards and regulations to address a number of previous concerns. This may be connected with listing requirements in a particular market (Sarbanes Oxley) or sector-related regulation such as the FSA regulation of the UK banking sector.

Even those listed companies not burdened by regulation nevertheless have experienced an increase in governance and reporting requirements for all operational aspects of the business. Derivative transactions and the potential losses continue to focus attention on Treasury operations.

We are increasingly being asked by audit committees, heads of internal audit and Treasurers to review and benchmark controls over their treasury operations. There are broadly two key categories of these reviews:

• protection of company assets; and

• financial reporting (internal and external).

Asset protection

The unusually high risk nature and size of derivative transactions entered into by treasury dealers requires specialised controls designed to mitigate the risk of loss from a ‘bad trade’. These controls revolve principally around the deal capture and accounting processes.

The design effectiveness of these ‘operational controls’ greatly affect both the security and efficiency of the treasury department. Many companies have successfully automated large elements of the control processes to minimise the impact on operations.

Governance

More than just looking at internal reporting; the governance of treasury operations commences with the Board setting policy in line with their appetite for risk. Without the right level of focus, the value from these controls, which are ultimately to protect the assets of the company, may not be realised.

Internal reporting

Internal reporting of treasury operations is a key element of any control framework. Is key information being lost in a mountain of detail, or omitted completely? Are the reports user-friendly, and who understands them?

External reporting

IFRS/FAS reporting requirements have placed additional burdens on many companies, and increased the focus on the disclosure of derivatives and of treasury activities. The reporting standard IFRS 7 adds the additional requirement of incorporating internal risk reporting into external disclosures. Is your company comfortable to disclose to the markets how you measure your risk?

Closely connected with control and reporting are the risks presented by complex financial instruments. Do you fully understand all financial products used in your company? Can you value them and test how they react as market variables change?

Sarbanes Oxley – the bar moves higher

With the introduction of Sarbanes Oxley, a new standard has been set for documenting and confirming the design and effectiveness of key treasury controls.

The core business of many companies is very different from corporate treasury operations. This provides a significant challenge to heads of internal audit to acquire expert resources to perform the internal audit of the treasury function.

Deloitte has significant experience working with leading companies in all sectors, and of varying sizes. Our expert staff are able to apply our methodologies to the specifics of your business using our broad experience in treasury management within corporates and financial institutions. We have in depth knowledge of derivatives, both plain vanilla as well as exotic, with underlyings like equity, fixed income, FX, credit, weather, commodities and statistical indices such as inflation. Our experience and practical approach allows us to identify cost effective solutions appropriate to the scale and complexity of your treasury operations.

We bring experts together with skill sets in corporates, banking, technology, taxation, accounting and project management to deliver superior results.

Deloitte has a broad range of services to assist you:

• Provide input to the design of a best practice control and governance framework;

• Perform analysis and review of your processes and controls to identify areas of improvement vs benchmark and best practices;

• Provide advice on how technology may best be utilised to automate processes and controls and improve the control environment in your treasury function;

• Provide assistance to perform effectiveness testing to confirm the controls as designed are operational;

• Provide assistance with derivative model validation, including mathematical implementation, the review of model parameters, key assumptions, the quality of data and stress testing of models;

• Given our vast experience in financial markets we are perfectly positioned to understand the impact of MIFID and its practical implications on your organization;

• Provide out-source and co-source assistance to internal audit departments. We can work with your internal audit team to either outsource or co-source your treasury audit requirements; and

• Provide assistance with Sarbanes-Oxley requirements for treasury, including documentation of processes, identification of risks and controls, design effectiveness, design of test scripts and performance of operational effectiveness.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.