EURO RISK MANAGEMENT In this second article on pragmatic euro preparations, 'euro risk management' is discussed - what is it and why every organisation that is doing business in the UK, Denmark or Sweden needs to undertake it. CONTEXT When twelve countries created the euro - the so called 'first wave' - three remained outside: the UK, Denmark and Sweden. In none of these countries do we have political certainty on whether and when they might join the euro. We can study the politics and try to interpret the pronouncements of the nations' leaders but in the end we are just guessing. Many organisations are putting off spending on euro readiness because of this lack of political certainty. With falling markets all around the last thing a financial institution wants to do is spend money on something that may never happen. And yet, in other ways that is exactly what they already willingly do, in four ways: - Nobody would dream of trading without due regard to market risk. Considerable effort is put into testing any trading strategy to examine the 'what if's of possible market movement. This costs time and effort and can often result in otherwise attractive trades being lost because the risk is too high. No institution ignores the possible changes in the market. - A similar tale applies to credit risk. - Increasingly operational risk is also being taken into account. Operational risk management is about considering what might happen to undermine normal operations and making process changes to head off the danger. - Finally, any financial institution that wishes to survive has in place a current Business Continuity Plan. This BCP will have been developed by analysing things that, if they happened, would pose a threat to the business. The BCP then records what the organisation will do in this event. A good BCP is a comprehensive document, going down to fine detail about exactly who will do what and with whom. In all these cases institutions protect themselves against what might happen. The point is that, even if you convince yourself the euro will not happen, you can't discount the possibility. We have a prime minister who uses words like 'destiny' to describe his approach to the euro. Even for a eurosceptic, hoping it will not happen is not the same as preventing it. This is where the euro risk management comes in. If the euro arrives it will impact your institution. It may be in terms of new opportunities which would be lost if you are not prepared, or it may just be operational changes you will need to make to protect your current business. In either case it is prudent to manage the risk that the euro may come. Think of it as a 'euro BCP'. HOW TO MAKE A EURO RISK ASSESSMENT Unsurprisingly the steps are rather similar to those of any other risk management undertaking, although with the simplification that only one eventuality is being planned for - a decision of the country in question to join the euro. Step one Conduct a full impact assessment. Many institutions will have started on that, perhaps as long ago as 1998, but is it still relevant and is it detailed enough? Vague pronouncements about impacted areas are not enough. Impacts need to be understood at the day-to-day process level. Step two Process alignment. This involves taking your detailed existing processes and defining a euro-compatible equivalent for each one. Consider also new business opportunities and the processes and IT that will be needed to support them. Step three Prepare the detailed action plan. This will show how these process and IT changes would be implemented. It includes costs (for getting the budget) and timescales. Review these timescales carefully - lead times can be a problem and there may be things that you need to do even before there is certainty of entry. Step four Reviews. This step is fundamental: your plan must be kept up-to-date. Periodically review the euro risk assessment to make sure it is still relevant. And if you define a new business process make sure it is euro risk managed at design, not later. CONCLUSION By following the four-step process above you can participate in the euro debate from a position of security, knowing that whichever way the decision goes you have a clear future direction across all of your organisation. ABOUT THE AUTHOR John Turner is Solving's principal euro consultant, with over 23 years' experience in business and technology consultancy in the financial services industry. He specialises in providing business and systems strategy assistance and has a particular interest in the euro, having lead nearly thirty assignments with organisations varying from small departments to major multinational banks. He speaks at conferences discussing issues related to the financial services industry and is often quoted in the press and industry journals. This article looks at what International Cash Management (ICM) is and how if implemented over the web it can bring significant benefits to banks who are involved in servicing large and medium sized companies. Within the international environment there has been a significant move by larger and medium sized companies to consolidate the accounts held abroad with correspondent banks in order to reduce their internal cost structure. In a group company structure the overseas branches have traditionally looked for the lowest cost providers of banking services in the country in which they are based. This may mean that, overall for the group, there are multiple banking relationships in order to provide the right banking services at the right price for each branch. For the parent company this means there are a potentially a number lost opportunities - and lost opportunities in the corporate sector tend to represent a marketing opportunity for the banking industry. Banks have a key role to play because they can provide ICM facilities that: - Provide liquidity management across the group - Create a centralised cross border payments facility for low and high value payments - Centralise collections - Centralise billing Banks have already realised this and have to some extent developed and implemented solutions to address these areas. However, there are other drivers in place which are forcing the banks to go even further: Competition - Larger banks who have their own global networks are driving down cost - UK euro entry may allow European banks to attack UK customer bases and allow UK banks to move into Europe Increased globalisation of corporate clients - Clients requiring an increased international reach - Clients looking for improved liquidity management (especially cross border liquidity management) Domestic market conditions - New demand for international services from the larger SMEs (small and medium sized enterprises) - Large domestic corporates are now willing to split from their traditional lending bank to consider taking ICM services from another provider Cost reduction - Government legislation is demanding reduced costs for corporate banking transactions - Drive to achieve increased STP rates and therefore to reduce costs Technology - Ability to support secure transactions over public infrastructure (SwiftNet, internet, VPNs) - Web front-ends facilitating ease of roll-out and support to customers. Given the above drivers what problems do banks face when setting up an ICM operation? Take a look at figure 1 which shows the links between the client, the client's bank and external parties. Key areas to consider are: 1 Connectivity. Web based cash management facilities are now the norm as this provides a single platform that reduces costs, provides a unified service across regions and allows centralisation of payment functions 2. Cash management software. Building a cash management solution from scratch is risky and it may lead to banks not keeping up with latest technologies and industry and market changes. The cash management software market has a number of players and is highly competitive and so it is now possible for banks to select and implement the best solution from a wide list of potential suppliers. 3 Partner banks. It is necessary to partner with other bank(s) who can provide an international coverage in specific regions (e.g. Asia, Africa, etc). This requires selection of a set of partner banks and will include the establishment and monitoring of SLAs. 4 Payment gateway integration. Integration with the partner bank network will be required as well as the creation of a pricing model with each of these partner banks. Where payments are to be handled by the host bank they must be able to handle the settlement methods and file formats of the Automatic Clearing Houses (ACHs) in each country. 5 Back office integration. Integration will be required between the product processing systems, the payments gateway and also the client interface. For security reasons banks will not allow direct update access to the back office systems and therefore interim files generated at the front end need to be processed in the back office systems. This is also the case with the corporate client and their ERP systems. Therefore the cash management software needs to ensure that these hand-offs can be implemented securely and effectively. 6 Validation rules. Validation rules held in the back office systems need to be included in the front-end in order to prevent downstream failure. There are now a variety of solutions in the vendor market place which provide web-based ICM solutions. These solutions address, to varying degrees, the above problems. Figure 2 shows the key components of a typical cash management solution. They include the following: Delivery and scheduling. Provides a proactive monitoring and notification mechanism so that the corporate client is made aware of significant events, error conditions or key statuses occurring on their accounts or with instructions they have already sent. This control can occur across a number of channels with a default set for each client. Desktop configuration. Allows the corporate client to create their own "look and feel", including own branding to the ICM front end. Client manager. This covers how the corporate client will set up their own rules for products, transactions, billing and authentication. For example a transaction rule may state that only payments over a certain amount are permitted. Product manager. For each product or service available this sets up the product characteristics for the whole product life cycle. For example the product definition will specify the charging rules, the templates will determine what information is to be captured and the routing rules will govern the flow and timing of the information. Processing engine. This is the heart of the cash management system and contains the key functional requirements of the solution. Account management allows bank accounts from a number of sources, including external bank accounts, to be set up. Liquidity management sets up the rules for sweeping and pooling including the identification of slave and master accounts. Payments management processes international and domestic settlements and also allows the verification and processing of bulk payments. Reports. Supports the definition of reports to generate for corporate clients and bank users. Includes how reports will be scheduled and how output will be generated. Security. Controls access to the ICM service via physical devices as well as through login access and menus. Integration. As there is a large interfacing element to the cash management service then an integration tool is required to facilitate the integration exercise. Standard connectors, e.g. for SWIFTNet, would be included as part of the integration facility. Data protocols. There are many payments methods available based on differences in the national systems where these transactions are to be executed. These multiple data protocols should be known within the cash management systems to allow conversion to the appropriate file format. Conclusions There are clear cut reasons for banks to offer an ICM service to their corporate clients. The trend is now to provide these services over the web which ensures best "bang for buck" and centralised control. There are sufficient vendors in the market place to provide competition and innovative thinking for cash management solutions. Banks should therefore ensure that they are in a strong position to serve their corporate client ICM needs and that they have a strong business case built for progressing with any web-based ICM initiative.