Peer perspectives on treasury risk: Controls, tolerances and managing expectations

Alexandra Lewis, Group Treasurer of National Grid, is interviewed by David Wiggins of Bloomberg LP to discuss her approach to risk management ranging from identifying their investors risk appetites, automating their control structures and processes along with their treasury systems. Also discussed is creating a framework that empowers treasury professionals to focus on adding value in more remote working environments.

Q: What is your treasury team’s approach to managing financial risk?

A: ‘Risk’ is not a bad word and certainly not in the way we approach it. What we try to do is look at risks and ask: what are the risks that I can manage and feel positive about being able to create return from? Those are the risks that we should be taking. Whereas there are other risks that shouldn’t be part of our playbook at all.

We also approach it from the point of view of ‘what do our investors think that they are investing in when they’re investing in National Grid?’ For example, if our investors expect to be investing broadly 50/50 in UK Sterling and US dollar investment, we wouldn’t want to hedge all our dollar exposure on our own earnings.  If we did that, we wouldn’t be giving them the exposure that they are looking for.  In other words, risk is something that investors want to take to get a return. And ideally, they’ll get a return that is commensurate with the risk they’re taking.

Q: Who are the stakeholders involved in setting your risk tolerance, and what types of risk are they putting under consideration?

A: Let’s narrow it down to financial risks for a moment. National Grid’s board has a finance committee that focuses solely on financial risk, largely because we have a significant debt book that enables us to create value for both customers and investors – but that does bring with it higher financial risk.

We begin by thinking about what our risk appetite is across all the different areas of financial risk that we’re exposed to. We then break that down into its component parts:  interest rate risk, FX risk, refinancing risk, counterparty risk, liquidity risk and so on. Then using our established frameworks for risk management, we try to categorize what it looks like to be risk-averse, risk-neutral, or risk-tolerant for each of them.

Instinctively, one might think we’d be more likely to take more risk in one area or less in another – but actually it’s about understanding what more or less risk looks like and how that might play out. We look at what the impact on us might be – from a financial and a reputational perspective – if the risk outcome was positive or negative.

Q: You talked a bit about how important investor expectation is. How do you determine what your investors’ risk appetite is?

A: Our Investor Relations team play a key part in this, so we’re closely linked into them. We get feedback from both equity and debt investors through our regular investor roadshow meetings, annual investor surveys and Capital Markets Days to provide insight into their expectations. Of course, we can monitor the markets, for example, to see what’s happened when the dollar has moved and correlations with the share price.

But overall, it’s a continuous combination of anecdotal and qualitative feedback, constant monitoring of data, and close interaction with the brokers and the banks, that enables us to understand what our investors are investing for.

Q: Has National Grid’s treasury structure and systems evolved over time to help manage to the agreed upon risk appetite?

A: We’ve always been a well-controlled Treasury, but we’ve come from a position where we were doing a lot manually and therefore more slowly.  In the past few years, we’ve taken opportunities where we can automate using robots, or to enable straight through processing, which then has reduced the amount of time the team is taking to get things done.

We’ve just gone through a two-year process to replace our treasury management system. The goal throughout has been to add as much automation as reasonably possible to make it simpler for our teams to operate within the policy and operate all the controls.  When possible we’ve also had an objective to not make the new system bespoke but instead to adapt our policies to fit into it – so that upgrading the system as new modules are rolled out in the future will be simpler.  The aim has been to make it easier for the team to get things done within the control framework that we operate – freeing up time for more value adding activities.  At the end of the day, these are highly skilled workers that we employ and with automation we’re enabling them to add more value.

“These are highly skilled workers that we employ and with automation we’re enabling them to add more value.”

Q: We hear corporate treasurers talking a great deal about automation, but some have been slow to adopt, or haven’t at all, because thinking about the work required gives a lot of organizations quite a headache. What motivated you and other stakeholders to begin the process?

A: It has to do with my own passion and why I love my job. And the reason I love my job is because I get to solve complex financial problems.  I’m not excited by systems upgrade projects on their own – what excites me is the vision of what we will be able to do and create, and the value that we can add to the business, to customers, to shareholders, to all our stakeholders. To be able to say how much value we added by the things we changed with applied judgment and strategic thinking is something that’s really important to us as a treasury.

Manual intervention and manual control equal time. And it’s time that can be spent adding value for National Grid: either by undertaking more value adding transactions, or by giving our people a better work-life balance.  Our people are a critical asset. If you lose good people, no matter how good your system is, you’re not going to deliver the value that you want.

“If you lose good people, no matter how good your system is, you’re not going to deliver the value that you want.”

Q: You have a much more active approach to interest rate risk management than corporate treasury departments typically have. Why is that so?

A: I think it stems from having a big debt book, where small margins on large principal amounts can impact quite significantly on the financial results. And I guess we’ve always had a risk-based way of thinking about it.

We’re not a profit center. We don’t speculate — yet we are happy to take more risks, and we have a track record which shows that to be a positive thing.

Q: The financial climate is changing. Switching from a fixed rate of interest to a floating rate of interest when rates had been low for so long was an easy choice. But with inflation levels rising, people now have to ask themselves: Is paying a fixed rate a good thing if the expected direction of interest rates is upward? How do you go about tackling similar issues?

A: In our business model we’ve always got exposure to interest rates and that interest rate risk exposure is most likely going to grow over time as our asset base grows.  We finance over 70p in every £1 of capital expenditure with debt, so the growing capital expenditure we are expecting, together with refinancing maturing debt, means that we will likely be issuing well in excess of GBP4 billion of new debt every year.  So it’s part of the business model.  Our regulatory frameworks allow us to recover efficiently incurred interest costs within our regulated operating companies, so we need to make sure that we’re efficient in the way that we issue debt to get the best rates we can.

Q: If you want to change your approach to managing financial risks how do you get senior buy in?

A: I approach it as a business case, as much as you would any investment. What is the proposal? What are the options? What is the value of each of these options? What’s the risk of each of these options? And based on all of that, this is the option we are recommending. It’s different from an investment in assets that you put in the ground, but it is still an investment in assets of a sort; people and systems, that enable us to deliver the value. On our team we’ve been managing those risks for a long time, and therefore, there’s a track record of the value that we can add by doing that.

Q: How do you evaluate your risk management process?

A: Once we align on the risk appetite of the finance committee, we then set up an annual review. The way we do that is to say, ‘Okay, let’s look back over the last year. Have we been operating within the risk appetite that the finance committee has set? Have we been taking on more or less risk than we should have?’ Usually, people see risk as a cap and make sure that they are not taking too much risk, but don’t focus so much on the floor and ask whether they are taking too little risk. It’s very easy to think that risk is something that needs to be jumped on and wrestled to the ground and pinned down. But sometimes if you’re taking a calculated risk, then you’re doing the right thing.

“It’s very easy to think that risk is something that needs to be jumped on and wrestled to the ground and pinned down. But sometimes if you’re taking a calculated risk, then you’re doing the right thing.”

So we look at it both ways.  I think it’s a good habit to get into, to step back once a year and ask: does this level of risk still look sensible, given the environment that we’re in?

Q: Consultants have been talking about automation involving APIs and robots for years, but we are only really beginning to see these changes taking place in treasury projects now. How do you envisage financial risk management evolving over the next 5-10 years?

A: With a push towards empowering our people, like we try to do at National Grid. How much do I empower the teams to get on and do their job? I’m hoping that part of the output of this systems upgrade will be the right number of controls, but not too many. I need to make sure that my team feels like they’re not being checked and double-checked all the time.

When we’re looking at big sums flowing through our books, both the derivatives book and the debt book, and the bank accounts on a daily basis, there is a tendency to suddenly think “these are big numbers, and I need to be in control of that.” I’m not saying that’s wrong, but it is a balance. And to be clear, when it comes to operational risk, we are definitely risk-averse: there are no floors on that one!

Q: Reducing the operational risk does seem to play into the post-COVID world. Do you think that is going to lead to an acceleration of automation adoption?

A: I think certainly, as a sector, Treasury has proven that we can manage operational risks whilst working from home.  When I think about all the risks we’ve managed and the billions of pounds of commercial paper we’ve issued, as well as long term debt, derivatives, and all the cash that goes through our bank accounts since Covid-19 first happened, not to mention the commodity risks we’ve managed in the US; and all from our kitchens, dining tables, spare bedrooms, it’s pretty impressive.

“When I think about… all the risks we’ve managed… all from our kitchens, dining tables, spare bedrooms―it’s pretty impressive.”

As we look to what the new normal might be, I think I would characterize this as office workers who have flexibility to work from home. Now that we’ve been going back into the office over the last year, I’m already seeing the benefits of actually being face-to-face with people, dealing with things much more quickly. The right people are getting the right information at the right times and they’re able to input their views immediately. Of course, with a team that’s based partly in London and partly in New York and Massachusetts, we were already interacting virtually before Covid happened, and to be clear, not everything has to be face-to-face – but there are times when it’s more effective and efficient to be in one place.

The hardest thing I think is bringing new people into the team.  When teams are stable, working from home is a lot easier.  But when I think about people who are at university now or at school now, who are going to be in Treasury in ten years’ time and who we’ll need to get up to speed, I think it’s unlikely that we’ll be working five days a week at home.  We do need to have a hub where people can come and share ideas and learn.  So ideally, we’d come to a hybrid solution, and our processes and systems have to support that.