The treasurer and FX risk management: as owner of the process to effectively manage FX risk, the treasurer must build an interdisciplinary approach that cuts across all the firm's organizational silos.

The treasurer, as the owner of the processes to hedge financial risks, often becomes, explicitly or implicitly, the owner of the processes to manage financial risks. In the case of interest rate risk, for example, the treasurer typically owns the debt, investment and interest rate hedging processes. Consequently, it makes eminent sense for the treasurer to "own" the entire financial risk management process for interest rates, as all the key elements reside within his or her domain.

Because of this expertise and focus, it also often makes sense for the treasurer to own the processes to manage foreign exchange (FX) financial risks. This, however, is a much more complicated task and requires a great deal more business skill than the risk management that naturally falls within the treasury group's organizational purview. FX risk touches every aspect of the business. Consequently, as owner of the process to effectively manage this risk, the treasurer must build an interdisciplinary approach that cuts across all the firm's organizational silos. Trying to manage the risk solely through treasury will be less effective, the evidence of which will show up in increased volatility of business results.

Management of financial risks can be broken down into three stages: identification of the risk, assessment of the optimal amount of risk the company should bear and design of the programs to move the company from where it is to where it wants to be, in terms of risk management.

* Step One: Identification of FX Risk. Often, treasury sets up an independent process to identify FX risks across the company by regularly polling the various business units. This is a mistake. Typically, these business units already report results, projections and plans to headquarters through a regular and well-disciplined process. The last thing these units want is to have to respond to another ersatz planning process imposed by treasury. Business units do not give the same attention and care to this secondary process, making information on foreign exchange incomplete, not timely and often incorrect.

The correct way to identify the risks is to incorporate the FX risk identification process into the core planning and reporting process. This will assure the requests from corporate receive the same attention as the basic planning ones.

* Step Two: Select the Optimal Financial Risk Profile for Foreign Exchange. Once a company knows to how much risk it is exposed to, it must decide how much it wants to bear. This is a strategic issue that touches all aspect of the business, not just treasury. To start, this risk capacity assessment really falls to the CFO and CEO. The treasurer can advise, but it is not his role to make the final call.

In addition, the treasurer is not in a position to assess all the risks. While he knows how much it costs to hedge the risks using derivatives, he is not in a position to know the costs of shifting currencies in business contracts or sourcing inputs from different currency areas to mitigate exchange rate risks. Only the business units and planners can assess this. The treasurer needs to make sure the question of FX risks are analyzed and debated as part of the overall company tactical plan.

* Step Three: Putting in Place Processes to Manage FX Risks. Again, most of the company's natural hedging will be done outside of Treasury. It may be economic for the business units to put in place formal processes to match the currencies or receipts and expenditures and/or incentive plans that compensate business managers based on results measured in the company's functional currency, regardless of the currency in which the units transact. Both of these initiatives would lead to the natural hedging of foreign exchange exposures. Treasury staffs would only become directly involved when it becomes prudent to hedge the remaining risks with derivatives or other financial risk management tools.

What does all this mean for the treasurer? Foreign exchange risks clearly affect every aspect of a business, and their management requires implementation of company-wide processes. As the owner of the processes to manage these risks, a treasurer will need more than analytic skills or knowledge of how to execute derivatives. He or she will need the management and team-building skills to demonstrate to his peers and superiors the merits of building cross-functional processes. Finally, a treasurer will need these skills to actually build and lead the processes. These are not bad skills for someone hoping to become a CFO to acquire.

James H. Hodge, a senior consultant at Treasury Strategies Inc., is a former treasury executive at AT & T Corp. and IBM Corp. He can be reached at [e-mail].