If you are asking yourself “I’m a data (warehouse) architect, why on earth do I have to know about Treasury?”, well, you don’t, if you are not in banking. If you are in banking, then you need to know treasury because it is a supporting function that all banks have. Whether you are in Fixed income, FX, equity, credit risk, market risk, commodity, or any areas of the bank, one way or another you will come across Treasury. Working in banking without knowing Treasury is like working in general insurance without knowing Underwriting. Yes, in investment banking Risk and Trading are important, but Treasury is equally important because it is one of the 2 divisions that underpins all other areas in the bank (the other is finance). A data architect must understand the subject area. Let’s start.
The core functions of treasury division in investment banking are Asset Liability Management (ALM) and Liquidity Management.
ALM manages 4 risks which occur because mismatches between assets and liabilities:
- Interest Rate risk
- FX Rate risk
- Credit risk
- Operational risk
Liquidity management ensures that the bank can pay all payment obligations when they are due.
- Maturity profile (all liabilities – funding and issuance)
- Set the limits (for funding and bond issuance)
- Cash flow – monitor and forecast (incl central bank)
- Monitor funding (secured and unsecured)
- Stress testing – baseline, adverse, severe scenarios
- Asset liquidity (assessment)
- MTM (Mark To Market) basis, not book values
Stress test factors: FX rates, prices, interest rates, economic.
- Baseline scenario (moderate expansion): GDP 2.75% up YoY, unemployment 6.75% in 2015, property up 3% per year, 1Y T bill up 20 bps per quarter to 2% in 2015.
- Adverse scenario (moderate recession): GDP -2%, unemployment 9.75%, property down 6% per year, 10Y T bill 4% by end 2013.
- Severe scenario (severe recession): GDP -5%, unemp 12%, property -20%, int rates 0%, 10Y T bill 1.25%
A treasury division can have these trading desks: fixed income desk, equity desk, FX desk, money market desk, proprietary desk. These desks trade those asset classes not to take a certain position to make money, but to hedge risks.
Difference maturity profile in fixed income credit liabilities — trades CDS. For example, if the overall horizon of the bank position in FI credit is too long term (say 4.4 years) compared to asset maturity profile (say 3.3 years as the majority is corporate credit facilities), then they might buy and sell CDS indices (or single names) to pull the maturity profile of the FI closer, i.e. to 3.8 years.
FX trades are used to maintain stability relative to the balance sheet currency. For example, if the 30% of asset is in GBP and the B/S is in CHF, and the GBP is weakening to CHF, then the bank may consider closing FX swap trades. Treasury does not take FX position in order to benefit from FX directional trends nor from FX volatility, e.g doing Delta or other Greeks.
Props (proprietary desks) are desk which trades with the banks own asset. It can trade various instrument classes, e.g. FI, equity, FX or money market, even commodity.
By far, the busiest treasury desk is money market. It monitors the bank’s positions within central banks (not only position/balances, but also access to Central Bank’s facilities, i.e. limits), and against all counterparties. The bank trades money market instruments (e.g. CPs, T bills, CoD, repos, Eurodollar, etc) in order to minimize the liquidity risk. For example, if outflows are forecast to make liquidity low in the coming weeks, it is treasury primary job function to eliminate the cash flow risk by tapping funding from money markets, at responsible costs. The funding profile also triggers money market trades, e.g. bond and equity issuance (capital markets) are long terms, hence treasury go to money markets for short term “fill in”. Treasury can also issue CPs, in addition to trading CPs, as investment bank’s ratings are usually triple As or one notch under.