Treasury Management

SSBM, Semester III

Batch 2011-13
Slides – Week 7
 Developments
• Inflation number
• US 10Y
• NIFTY
• INR

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 Week 6 Agenda
• Analysis of Central banks statements
• Swaps Recap
• Global Markets
• Forwards
• Foreign Exchange Markets
• Risk Management
• Valuation and MTM

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 Week 7 Agenda
• Ethics – Concept
• Relevance in Finance
• Mitigants
• Basic Principles of a Code of Conduct
• Key Stakeholders for Ethics
• Cases

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 Ethics
• Meaning
• Context of work culture
– Aggressive, Compliant, Client centric, Transactional
• Moral Philosophy
• Concept of right and wrong behavior
• Given a certain situation what is recommended
– Checks and balances
– Penalties for adverse selection

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 Ethics in General
• Are people in finance less ethical?
– Ethical dilemmas exist everywhere
• Cheating, Fraud, crossing the ethical line
– Opportunity
– Stakes
– Penalty
• The Tipping Point, Malcolm Gladwell
• Ultimatum game
– B has to decide on the payout for both
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 Ethics in Finance
• One View is that Banking is about trust
• Credit derives from Credere = believe
• Billions of transactions happen on the basis of trust everyday
• Contrary is the view that finance is concerned with the end
not the means
• The Complete Book of Wall Street Ethics is fat, bound and
blank
• Yes the opportunity and temptation are high
– Denis Levine, DBL, insider trading
– Satyam books cooked for 10 years
• No evidence to show that financial sector members are more
or less ethical but incidence could be more
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 Specific to Banking
• If a Bank wins, shareholders and management
benefit
• If a Bank loses, the public loses which bails
them out
– Privatization of profit and Socialization of cost
• This tilts the balance of operating a bank more
towards ethical behavior than otherwise

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 Famous Ethics cases in markets
• Enron
• Barings
• SocGen
• Harshad Mehta securities scam
• Satyam
• MFI cases
• Barclays

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 Ethics in Treasury
• Critical in the Treasury due to the nature of work
– Involves use of confidential information
– Large balance sheet impact
– Requires following standardized practices due to
large volumes
• Standards of honesty, professionalism and
integrity expected are the highest
– Employee represents the institution directly
– Delegated authorities are higher than other parts of
the bank
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 Mitigants
• Evolve a code of conduct
• Use technology/ systems to check/ prevent/
highlight
• Multiple Checks, Audits
• Penalties for breach to be large and act as a
disincentive
• System of incentives needs an overhaul
– Variable needs to be spaced out
– Variance to be reduced though in practice this difficult
and undesirable
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 Basic principles of a Code of Conduct
Code of Conduct
• Maintain the highest Reputation
– Of the institution and of the market
– Organization Compliance procedures
– Rules of Public communication
– Relationship with regulator
• Respect for Rules/ Regulations
– AML
– Confidential Information
• Trading prohibited
• Chinese Walls
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 Basic principles
– Market Manipulation
• Artificial prices
• Affecting natural demand, supply
– Off Market rates
– Segregation of Duties – Front / Mid/ Back Office
• Integrity
– Clear communication
– Firmness of quotes
– Rumours, misrepresentation
– Collusion
– Deal concluded is done
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 Basic principles
• Conflicts of Interest
– Gifts, Entertainment Policy
– Personal gain from official information
– Personal Account trading
• Competence
– Induction for New joinees
– Regular Training for Dealers, Accreditation
– Limits and Authorization documents
• Responsibility
– Substance abuse on duty
– Complaints mechanism
– Whistle blowing
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 Basic principles
• Client Interest
– Misselling products
– Collusion with clients

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 Code of Conduct
• Reputation
– Action of the treasury staff must be such that the
reputation of the institution and of the market is
enhanced and never compromised
– Knowledge of the current regulations
– Knowledge of internal compliance procedures
• Respect for the above will be required by treasury staff
– Public communication should be made only by
trained, authorized, senior staff and they should
act in the capacity of a spokesperson for the bank
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• Regulator Relationship
– Very critical for a bank to maintain a cordial, open
and transparent relationship with the regulator
• Respect for Rules/ Regulations
– Demonstrated compliance
– Penalties for breaches, record
– KYC, AML rules to be followed
– Handling confidential information
• Policy for non public information
• Chinese walls to be strictly followed
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• Market Manipulation
– Traders should deal on genuine on market prices
and avoid all off market prices or price distortions
– Any actions affecting natural demand and supply
should be avoided eg misleading prices
– Off market prices, artificial demand supply are to
be reported

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• Segregation of Duties –Front/ Mid/ Back
– Conflict of interest is avoided through segregation
– Access control, physical separation preferred
• Whistle blowing policy
– Approachable management
– Regular interaction
– Repeated message about ethics, confidentiality
and goals

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 Gifts, Entertainment Policy
• Well documented, well communicated policy
– Cover most situations
• All employees should follow the rules, no
exceptions
• G&E register for all gifts above a certain
threshold
– Auditable record, monthly noting
• Collusion with brokers or clients is a key risk

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 Key Stakeholders
• HR of the bank
– Ensuring fit
– Communicating the Culture of the bank
– Disciplinary action
– Access for whistle blowing or reporting of seniors
• Compliance Function
– Ensuring adequate communication
– Access to Regulator for clarifying grey areas
– Investigate any wrong doing/ allegation
– Disciplinary action
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 Key Stakeholders
• Self Regulatory Authority
– FIMMDA – Fixed Income Money Market Dealers
Association
– FEDAI – Foreign Exchange Dealers Association
– Prescribe a code of conduct
– Handbook for dealers
– Arbitrate disputes between members
– Discuss and deliberate new regulations and consolidate
feedback to regulator
– Act as a conduit between regulator and market
– Implement new products, best practices, training
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• Bank Board
– Final responsibility rests with CEO
– Governance through various delegated
committees
• Compliance
• Audit
• Risk

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 Dealers Handbook
• Firm price vs Indicative
• Level vs Price
• Keep terms firm for a reasonable period
– Time limit
• Standard terminology, lot size, parameters,
conventions
• After Hours Dealing and Off premises Dealing
– Avoided unless necessary
– Specific approvals needed
– Recorded separately, audited
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 Case: Everyone Wins..
• You have recently completed your MBA and have
joined a stressed asset firm which deals with asset
disposal.
• You are working on an assignment which is the
sale of land that belongs to a company which has
gone into liquidation post NPA.
• The sale terms require that bids have to be
received by 5pm that day (Friday)
• Some bids have been received but not as many as
anticipated.
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 Case: Everyone Wins..
• The land sale is a key one for the lending bank in
terms of recovering its money against NPAs which
have been provided for
• You have a movie program with your friends at
6:00pm Friday evening and are keen to get there
on time
• At 4:30pm you get a call from a prospective buyer
who wishes to remain anonymous. He informs
that he is very interested in the land but does not
want to pay an unreasonable amount
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 Case: Everyone Wins..
• He makes the following proposal
• He will pay 10% over the highest bid received at
4:58pm provided details are given to him
• He claims everyone wins since
– Your firm wins a higher fee
– The bank receives the highest bid
– He wins since he doesn’t have to make an
unreasonable blind bid
– Further he says you would be personally rewarded
for your hard work
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 Case: Everyone Wins..
• The caller claims ‘Transparency is the best
policy’ and this is best outcome for all and no
one loses
• The firm, the bank both could benefit
• You advise that this is not the way you or your
firm do business and that he should follow the
rules and make a bid before 5pm

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 Case: Everyone Wins..
• The caller respects your view point and integrity but
says:
– This is common place in this industry
– Without naming says more senior personnel in your firm
have done this in the past and his terms are very generous
• Further, the caller states that if the bank later found out
that there was a higher bidder it would be unhappy.
• This would affect the firms business and your career
• The caller says he will phone back in 5 minutes for a
decision and hangs up

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 Case: Everyone Wins..
1. What do you do now?
2. What are the readily identifiable ethical
issues?
3. Who can influence your decision?
4. Who is affected by your decision?
5. Professional Integrity or Firm’s profitability
which should predominate?

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 Case II: We are all in it together
• Read the following case and discuss the
following questions

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 Case II: We are all in it together
• What do you do next?
• What additional controls can be put in place to
prevent this in future?
• Can you inform the Board, Implications?
• Does the code of conduct specify penalties?
• Who are key parties influenced by your
decision?
• Should unknowing involvement be treated
differently
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 Further reading
• FIMMDA handbook
• FEDAI code of conduct

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 Questions
• How do you satisfy yourself that the process
of awarding the IT contract has not been
distorted
– Giving due consideration to
• Integrity
• Objectivity
• Professionalism
• Confidentiality

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 Questions
• Issues to be raised
– For you personally
• Have you done enough?
• Postpone the decision
• Discuss with legal/ auditors
• Find evidence of conflict, present
– For the company
• Policy on related parties
• Is disclosure of interest a regular board item?
• Suggest a Competitive tender
• Feedback on Extravagant from other customers
• Should you use information given to you in confidence?
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 Accounting Norms
• Investment Portfolio of Banks
– Debt Securities
• Govt Securities, State Govt, Govt Guaranteed Bonds
• PSU Bonds
• Corporate Bonds
– Hybrid
• Prefs
• Convertibles
– Equity
• Shares
• Warrants
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 Accounting Norms
• RBI stipulates that at the time of acquisition
the investment portfolio be classified as
– HFT
– AFS
– HTM
• The detailed accounting treatment then
follows for each portfolio

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 Accounting Norms
• Profit Accounting
• General Principles
– Accrued interest paid is an expense
– Accrued interest received is an income
– Book value is the clean price
• Brokerage if any to be adjusted
– Inter-category transfers to be at lower of book
value or market price
– LIFO/ FIFO or weighted average for portfolio
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 Valuation Norms
• Prescribed by RBI, operationalised by FIMMDA
• HTM
– At cost
– Any premium to be amortized on remaining life
– No MTM needed
• AFS
– MTM at least once a quarter
– Any depreciation hits P&L
– IFR is used to debit/ credit the P&L number
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 Valuation Norms
• HFT
– MTM necessary at least once a month
– Appreciation ignored, depreciation flows straight
to P&L
• Valuation methodology
– Conducted by Finance/ Mid office
– Governed by RBI circulars
– Process to be Audited regularly
– No front office involvement in valuation
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 Exposure Norms for Banks
• Reserves/ Limits to manage the various risks
• Volatility – Market Risk
• Measure of risk appetite of the organization
• Credit Risk – Compared to advances/ retail this
risk is lower
– Quantitative controls – Limits by name
– Based on net worth/ repayment capacity
– Uses – Call Money Lending, CP, IRS MTM limit

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 Exposure Norms for Banks
• Credit Risk
– Qualitative Control – Limits by rating, industry,
strategy
– Uses: Corporate Bond trading, CDS, FX exposures
• Market Risk
– Computed for the various markets – Bonds, FX
– VaR is the key measure for Market Risk
• With a certain confidence level, predicts the max
probable loss on a position using historical volatility
– Notional limit, Ageing Limit, PVBP
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 Exposure Norms for Banks
• Market Risk
– Intraday limits (can be several times the overnight
limit) are also key and monitored by Mid office
– For FX books, Aggregate Gap Limit (AGL) is
monitored which is a measure of all open
positions ignoring the sign

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 Exposure Norms for Banks
• Settlement Risk
– Risk of default in settling cash/ securities/
obligations as per a deal
– Herstatt Risk- withdrawal of license caused the
bank to renege of its commitments
– Mitigating this risk
– DVP : simultaneous settlement
– Clearing houses, CCIL
– Setting a limit

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 Some settlement risk terms
• Pre-settlement risk: Risk on banks books prior
to settlement day
– Replacement Cost or MTM of deal
– Current Exposure Method or owed MTM plus
– Potential Future Exposure or PFE is a measure
computed by multiplying the Credit Conversion
factor to principal

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