Control and procedures

Here you can find a list of definitions for terms associated with control and procedures. These terms are listed alphabetically, alternatively you can use the find facility within your internet browser (by pressing control + F simultaneously) to search for terms within this page.

Authorisation

A key control in treasury. Authorisation needs to be provided for all transactions in treasury and given only by a small number of people with the appropriate (seniority) qualifications. The individuals with power of authorisation should be listed in a document also specifying the various transactions that can be authorised, procedures for controlling authorisation, etc.

Authority Limits

Limits set by treasury to the number of dealers allowed to carry out transactions, the value of the transactions they can execute and the number of people giving authorisation. More generally, limits can also be applied to the financial risk that a company or organisation is willing to bear. Limits can, for example, be set for the proportion of foreign exchange exposures and the time period within which they should be hedged. The company/organisation may also, for liquidity reasons, limit the types of deals that it wants to have transacted. Another area of authority limit concerns the level of counterparty credit exposures resulting from deals such as those in derivative products. In some exceptional situations, the dealer may have to exceed the risk and authority limits set by the management. In such cases, it is essential for the dealer to have the transaction approved by the relevant responsible manager.

Cash Flow Forecast

A regular report sent by the company's operations and subsidiaries to the treasury management headquarters informing about any cash excesses and deficits that they may have in the future. This is highly important for the respective group treasurer when making investment, funding and hedging decisions.

Confirmation

The final leg of a (treasury) transaction/deal that occurs when a deal has been transacted and recorded. The basic principle is that the party that initiates the deal sends out a confirmation letter to the counterparty providing all the relevant information on the deal. At the same time, the counterparty sends a letter of confirmation to the company. Confirmations serve as legal documents protecting the company as well as the counterparty against the risk of default when payments mature. They need to be checked against the deal tickets and signed by the respective authorised people before being sent out. An important rule with regard to confirmations is that they must not be received by or sent to people with dealing functions. Increasingly confirmations are being transmitted and matched by electronic means, but the same rules, relating to the separation of the dealing function from the confirmation function, still apply.

Counterparty Credit Exposure

The exposure resulting from treasury transactions between the company and its counterparties. In order to reduce the counterparty credit risk (i.e. the risk of default by the respective counterparty), it is of great importance that the creditworthiness of counterparties is assessed regularly and accurately. The overall counterparty credit risk can be broken down to:

• Capital risk – the risk that the company may lose its entire investment due to default by a counterparty which holds a deposit or has issued a certificate of deposit;
• Price risk – the risk that the counterparty may not fulfil their part of the transaction at the agreed price. In such a case, the company may have to find another party to carry out the same transaction at the current market price. The concrete price risk is then the difference between the previously specified price and the final price of the transaction;
• Settlement risk – the risk that the counterparty fails to settle the transaction on the agreed date.

Counterparty credit exposure management basically consists of reviewing the creditworthiness of counterparties, of setting credit limits for counterparties, of evaluating credit risk and of reporting credit limits and exposures to management.

Dealing Procedures

Procedures that aim to ensure that unauthorised treasury transactions do not take place. Before carrying out a transaction, it is important for the dealer to receive competitive price quotations so that deals are transacted at market prices. Deal tickets, which record all treasury transactions, represent important control documents that need to be produced as soon as a deal is concluded. Transactions with regard to derivatives should only take place with counterparties having a master trading agreement with the company. This agreement contains all arrangements concerning payments in the case of default by one party and the law applicable to the contract.

Electronic Funds Transfer System

A software system, provided by a bank, that enables companies/organisations to process incoming and outgoing payments electronically. For security and control reasons, authority to use the system is highly restricted. The EFT procedure may consist of up to three stages:

• Input, where an operator is provided with an identification card and a password to access the system and to enter transaction data;
• Verification, which refers to checking and controlling the transactions that have been input;
• Authorisation of the transaction, which is given when all data are entered correctly and accurately.

In order to maintain the basic principle of the segregation of duties, the three different tasks should be assumed by ideally three different groups of authorised people. Once the transaction has been authorised, the relevant data are sent through the EFT system to the software-providing bank's transmission system where the transaction will be effected.

Execution

The stage of the trading/transaction process when the trade/transaction is carried out. In a treasury context, this refers to treasury transactions taking place in the bank to which the company is connected via its EFT system. The bank receiving the transaction data will confirm this to the company and send a transaction number, which may be used by the company in case of any questions. By doing so, the bank assumes the responsibility to transfer funds according to the company's transaction instructions.

Financial Risk Sensitivity Analysis

An analysis that aims to identify the possible impact of market movements and variables such as interest rates and exchange rates on the financial situation of the company with regard to cash flow, portfolio of derivatives, funding, foreign exchange exposure, etc. Financial risk sensitivity analysis is important for the management of the financial risks of a company.

Mandates

From a treasury perspective, mandates are agreements regulating the dealing relationship between the company and its counterparties, authorising people to conduct transactions, possibly applying limits to the size of deals and procedures concerning settlement, and regulating the opening and closing of transactions. Mandates are a key element of treasury controls and are an essential mechanism for reducing the company's dealing risk.

Recording

The documenting of financial transactions. Recording of treasury transactions not only serves to process them properly in the company's treasury and accounting systems but also helps senior management to make the right risk management decisions on the basis of up-to-date information.

Reporting

Generally, the providing of in-depth records of the activities and performance of financial or other operations to management by internal or external providers. From a treasury perspective, reporting includes a detailed record of treasury transactions and performance on treasury activities. In particular, reports should be produced to provide information on the company’s cash flow, foreign currency transaction exposure, debt positions, portfolio of derivatives and counterparty credit exposure. It is an important tool that allows the senior management and the board of directors to make sure that the treasury activities within the company are in accordance with their defined treasury management policy.

Segregation of Duties A risk management technique, used when undertaking financial operations, that prevents one person from having overall control from initiation to settlement of a financial operation or set of financial operations. It is one of the most important principles in treasury management and control, since it ensures that different people are involved in several or all stages in a transaction, consisting mainly of the initiating, the confirmation, the recording and the settlement processes. Thus, the risk of error as well as of fraud is reduced considerably. An adequate separation of treasury responsibilities should be made between policy agreement, authorisation, dealing, transaction recording, limit monitoring, confirmation, transaction valuation, risk measurement, settlement, and finally reporting.

Although it is quite reasonable and useful to separate all treasury duties, it is also unusual in practice. The extent to which treasury duties are segregated depends above all on the size of the relevant company. However, certain functions will need to be fulfilled by different people. These sensitive areas concern dealing, confirmation, settlement and reporting, i.e. the person responsible for initiating and executing the transaction must not have access to the confirmation documents or be in charge of the settlement of transactions. Moreover, formal control in the form of regular reporting and reviews, which can be carried out by an internal audit, should be introduced.

Settlement

As is the case for other type of transactions, the settlement of treasury transactions is normally regulated through dealing mandates which provide for specific standard settlement arrangements with counterparties. The company's settlement system should enable it to track late payments and establish liquidity requirements and account balances. In addition, settlement should be based on the segregation of duties between the authorisation and transfer of payments.

System Log

A log that records all transactions in the EFT system and the number of those accessing the system in a single working day. Most software systems require operators to run a log before they can carry out transactions in the system.

Treasury Control and Procedures

Represents the formal framework underpinning the treasury management of an organisation ensuring that the treasury management policies set by the board of directors are complied with.

Treasury Management Policy

A precise, explicit framework for the management of a company's/organisation's financial risks. This should determine, among other things, for which purposes and under which circumstances hedging instruments such as derivatives may be used.

Unauthorised Transaction

An unauthorised transaction is one carried out:

• by someone who is not authorised to undertake a particular transaction;
• by someone, who is authorised to undertake transactions, but the transaction exceeds the size of transactions they are authorised to transact; or
• a transaction undertaken with an unauthorised counterparty or which is in excess of the dealing limit set for that counterparty.

See authorisation, counterparty, credit exposure, mandates.

Valuation of Derivatives

Valuation method used for pricing derivatives based on their current market value. The market values of derivatives fluctuate mainly with the respective prices of the underlying financial products. This volatility in prices represents a financial risk that the company has to bear and to manage. The valuation process stipulates that the treasurer update their portfolio of derivatives regularly in terms of market or fair value. Moreover, valuation should be conducted independently for different transactions in order to prevent the manipulation of pricing. Pricing based on derivatives pricing models or specific software needs to be documented accurately and controlled regularly.

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