The benchmarks set depend on the companies’ attitude to risk, so the fact that Tesco should operate it’s treasury on a profit centre basis pre-determines some benchmarks, such as the fact that they are able to leave some exposures un-hedged in expectance of rates going up and extra profit being made, or the fact that their hedge selectively policy and profit centre based treasury allows them to shop around for better rates for deals, not just being tied to one particular dealer means they have to search for the best rates and is thus measurable on past and future performance.
Using the exchange rate available at the beginning of the exposure as found on Reuter’s pages, the profit centre treasurer would be able to deal with other banks and negotiate a more favourable rate, or they could even leave the exposure un-hedged if they believe the rates will change in their favour.
Benchmarking the rate received against that on the Reuters page is a good method as it will measure what the market got compared with what the treasurer got, as a profit centre the treasurer hedges selectively and this means that on occasions they might get a much higher rate by leaving it un-hedged. However, they might also get a less favourable rate in which case the treasurer would not have met this target when comparing it with its benchmark. This is slightly unfair as they have a more risky profile company to play exposure trade offs with, but it also clearly shows what the treasurer would of got as a rate if they were not prepared to take risks like they do.
Or the ability of the treasurer to manage the exposure by internal techniques, e.g. matching of long and short positions by multilateral netting, but they would need to show that they did this to eliminate the exposure and add value.
The treasurer’s performance could be measured against whether they have followed policies in a sense that they have not breached their limits, they have taken appropriate risks as defined in the policy and they have met their reporting needs for derivatives. This is a very good way of measuring the performance, however, on occasions the limits might be breached and reporting might not be done due to circumstances beyond their control.
You could also benchmark against bank costs, dealer performance, exposure management and service levels to other departments.
When looking at bank costs, you could compare them with other banks to see if you are paying more with your bank, or compare them with previous years to see whether you have negotiated lower costs. This is a valuable method because sometimes people just use the same bank regardless of cost but more for ease of transaction and time, but on a profit centre they should be seeking to reduce costs and increase profit at all times.
When looking at dealer performance it would be along similar lines as the bank costs, comparing them with previous years and different dealers to see whether you got the best rate, again this is a good benchmark as it is quantifiable, as you could calculate what you have saved by using certain dealers.
The relationship of the treasury function with the rest of the company could be assessed by focus groups or questionnaires, where speed of response and quality of advice are factors considered. However, the treasury function may feel this benchmark is rather unfair since good quality advice and speed of response are taken for granted within the company.
Benchmarks could be based on what competitors have done, although this may be hard to find out exactly what they have done to give an accurate comparison. According to “It is natural for companies to wish to benchmark their performance against a handpicked group of major competitors. However, depending on individual objectives and business strategy, different companies, even within the same industry, have different strategic goals”.
- A Report on the implications of possible pension liabilities for companies:
The Pensions Act 2004 has given the pensions regulator specific powers to reduce the risk to member’s benefits that is caused by employer actions; this includes the contributions, financial directions of the company and restoration orders.
Possible pension liabilities for companies include the ageing population, we are entering an era where the amount of people that are drawing a pension will be far greater than those working and paying into the pension pot. This means that many companies will struggle to pay out large pensions and as such are closing schemes like final salary ones to try and limit their liability.
All pension liabilities must now be shown on the balance sheet; this produces a reduced profitability figure for the company and could result in increased borrowing rates, down-grading of the companies rating with Standard & Poors or other similar rating agencies.
Appendix 1 shows notes from Tesco’s 2005 annual accounts and reports brochure that relate directly to the company’s pension liability.
Changes in pension regulations mean that individuals will be able to take more cash tax-free from their pot from April 2010, this will have a diverse effect on any companies pension liability as it means instead of being able to invest their money for them and pay them out a monthly sum, they will have to release vast amounts of it in lump sums. This reduces the amount they have left to invest and can mean they get poorer deals and less returns for those currently paying into the pension pot.
As from April 2005 individuals can also take their pension and carry on working for some companies, Tesco in particular offer this option. It means that once they start receiving their pension the employers and employees contribution will stop, but they will have to not only pay out a pension each month or year but they will also have to pay out a wage each month meaning increased expense as you usually expect to be at the highest salary point when you wish to retire.
The new regulations also mean an increase in the percentage of their salary that the employee can contribute to the scheme, Tesco have agreed to increase their amount of contributions inline with what the employee contributes. This means that they will be paying more into the pension pot but it also means that individual’s pensions will become larger creating a larger liability when they come to draw the pension.
Appendix 2 is an internal company brochure on pensions. With reference to Tesco and the pension pot deficit that many companies are seeing, last year they took £200million of their profit and paid it directly into the pension pot to help reduce their liability.
Probably a suggestion from the treasury to do this as not only would it reduce their liability in future years, but it could also increase the rate of return they receive from investing it for their employees, a risk versus reward pay off.
One of the main factors that have started the pensions liability issue is the under performance of the investment that the pension managers made, this is not as a result of poor choice of investment but more of market performance. If pensions fund managers were to invest the same money into more secure investments like bonds they would be guaranteed their funds and normally plus some interest back at the end of the bond term. However, whilst this would reduce the liability because the employee knows their pension is safe and guaranteed, even if it is a smaller amount, this is often way less than the return one could get from investing in the stocks and shares.
- Identification and evaluation of relevant procedures for controlling the treasury function to mitigate the danger of fraud or human error:
The overall responsibility for internal control, risk management and setting of policies within Tesco rests with the Board of Directors; they have this controlling function to attempt to safeguard the Company’s objectives. They are responsible for identifying, evaluating and managing financial and non-financial risk and justifying the actions they take in response.
The Board of Directors set out a treasury policy which should contain sections on derivatives, what instruments can be used and for what purpose.
Basically is lays out in clear written format which type of centre they should be operating on, i.e. cost or profit, maximum exposure limits, treasurer dealing and authority limits, bank limits, valuation methods and rules and procedures for documentation, dealing and confirming deals and settlements.
In particular the bank limits rules will eliminate collusion between the treasurer and a member of the transaction bank which thus reduces the risk and attempts to eliminate fraud. It also reduces the exposure of having all Tesco’s financial transactions going through one particular bank and that bank entering into financial difficulties.
Recent developments in accountancy standards, IAS 39 and FAS 133, have forced Treasurers to keep meticulous records of all derivatives transactions and this has made controlling the treasury function easier. This enables the auditor, and anyone who needs to investigate the company, to see all the small details relating to any derivative transactions. These were brought about with the scandals like Barings Bank and Nick Leeson, and the Enron and Arthur Anderson scandal, along with the Sarbanes-Oxley Act.
Personnel can also play an important part in the issue of controlling the treasury function because they can use factors like recruitment and selection to select the ‘ideal’ candidate and eliminate those with more dubious references. They can also use training to ensure that their employees are continually up-dated with the latest regulations and allows them to know what is expected of them in their job role.
Again in personnel should be a rule that could be in the treasurer’s contract that stipulates they must take at least ten days of their annual leave in a consecutive period. This is very useful as it allows someone else to do their job for that two week period and find any errors or fraud that may be occurring.
Another method of controlling the treasury function is to set limits for dealers’ authority, individual bank limits, transaction limits etc. This enables the company to reduce any possible risk that might arise through one person having no dealing limits and no individual bank limits. Tesco use this method so reduce their risk as stated by one of the companies Directors “In our fast moving business trading is tracked on a daily and weekly basis, financial performance is reviewed weekly and monthly and the Steering Wheel is reviewed quarterly” Tesco Review and Summary Financial Statements 2005.
Tesco carry out post-investment appraisals to ensure that policies, procedures and performance are being met by all individuals.
They also make their treasury function produce reports on their policies at the end of each financial year, which are then not only reviewed by the Board of Directors, but by the internal and external auditors. This report is then used to review and amend any treasury limits and delegations. This is very useful because with the external auditors playing a part in setting limits and delegations for the treasury, this means tighter controls and less chance of human error or fraud occurring.
If the treasury and senior management is to receive daily reports as to any breach of credit limits, dealing limits, a list of all the deals done that day and any changes to standing data, this will enable senior management to spot any errors or fraud that is happening and produce immediate responses to stop and/or reduce this risk.
Finally, one of the other methods that could be used to reduce human error or fraud would be to outsource the treasury function. This would be a drastic measure and probably costly as it would be a service you need expertise in.
However, it would mean that the company can carry on with their main objectives and not have to worry about treasury policies, derivative policies, FAS 133 and IAS 39; it would also mean that they would not need to invest in state of the art technology to process instant transactions and record derivative details.
Appendix 1
Notes to Tesco Plc annual reports and accounts:
Note 27 Pensions
The Group has continued to account for pensions and other post-employment benefits in accordance with SSAP 24 and the Disclosures in note (a) below are those required by that standard. FRS 17, ‘Retirement Benefits’ was issued in November 2000, and the transitional disclosures required by that standard, to the extent they are not given in note (a), are set out in note (b).
For the financial period ending April 2006 the Group will adopt International Accounting Standard 19. The last full actuarial valuation of the main UK scheme was carried out as at 31 March 2002. The next full valuation will be performed as at 31 March 2005 and the results will not be known until the end of the financial period. An additional contribution of £200m was made in February 2005 to reduce the expected increase in the actuarial deficit since the last full valuation. Any decision as to the level of future contributions will be made once the results of the March 2005 valuation are known.
(a) Pension commitments United Kingdom
The principal plan within the Group is the Tesco PLC Pension Scheme, which is a funded defined benefit pension scheme in the UK, the assets of which are held as a segregated fund and administered by trustees. The total profit and loss charge of UK schemes to the Group during the year was £218m (2004 – £152m). A SSAP 24 pension prepayment of £221m (2004 – £12m) is present in the Group balance sheet, which includes the additional contribution of £200m. An independent actuary, using the projected unit method, carried out the latest actuarial assessment of the scheme at 31 March 2002. The assumptions that have the most significant effect on the results of the valuation are those relating to the rate of return on investments and the rate of increase in salaries and pensions. The key assumptions made were a rate of return on investments of 6.75%, a rate of increase in salaries of 4% and a rate of increase in pensions of 2.6%.
At the date of the last actuarial valuation, the market value of the scheme’s assets was £1,576m and the actuarial value of these assets represented 91% of the benefits that had accrued to members, after allowing for expected future increases in earnings and pensions in payment. The actuarial shortfall of £159m will be met via increased contributions over a period of ten years, being the expected average remaining service lifetime of employed members. The T&S Stores Senior Executive Pension Scheme is a funded defined benefit scheme open to senior executives and certain other employees at the invitation of the company. An independent actuary, using the projected unit method, carried out the latest actuarial assessment of the scheme as at 6 April 2001. At that time, the market value of the scheme’s assets was £5.8m and the actuarial value of these assets represented 110% of the benefits that had accrued to members, after allowing for expected future increases in earnings.
Overseas, the Group operates a number of schemes worldwide, which include defined benefit and defined contribution schemes. The contributions payable for non-UK schemes of £10m (2004 – £8m) have been fully expensed against profits in the current year. A funded defined benefit scheme operates in the Republic of Ireland. An independent actuary, using the projected unit method, carried out the latest actuarial assessment of the scheme as at 1 April 2004. At that time the market value of the scheme’s assets was £62m and the actuarial value of these assets represented 99% of the benefits that had accrued to members, after allowing for expected future increases in earnings.
(b) FRS 17, ‘Retirement Benefits’
The valuations used for FRS 17 have been based on the most recent actuarial valuations and updated by Watson Wyatt LLP to take account of the requirements of FRS 17 in order to assess the liabilities of the schemes at 26 February 2005. Schemes’ assets are stated at their market values at 26 February 2005. Heissmann Consultants (Ireland) Limited have updated the most recent Republic of Ireland valuation. The liabilities relating to post-retirement healthcare benefits (note 28) have also been determined in accordance with FRS 17, and are incorporated in the following tables.
On full compliance with FRS 17, and on the basis of the assumptions noted above, the amounts that would have been charged to the consolidated profit and loss account and consolidated statement of total recognised gains and losses for the year ended 26 February 2005 are set out below:
Note 28 Post-retirement benefits other than pensions
The company operates a scheme offering post-retirement healthcare benefits. The cost of providing these benefits has been accounted for on a similar basis to that used for defined benefit pension schemes. The liability as at 26 February 2005 of £7.4m, which was determined in accordance with the advice of qualified actuaries, is being spread forward over the service lives of relevant employees. £0.6m has been charged to the profit and loss account and £0.4m of benefits were paid. An accrual of £5.6m (2004 – £5.4m) is being carried in the balance sheet. It is expected that payments will be tax deductible, at the company’s tax rate, when made.
Note 29 Capital commitments
At 26 February 2005 there were commitments for capital expenditure contracted for, but not provided, of £416m (2004 – £501m), principally relating to the store development programme.
Note 30 Contingent liabilities
The company has irrevocably guaranteed the liabilities as defined in section 5(c) of the Republic of Ireland (Amendment Act) 1986, of various subsidiary undertakings incorporated in the Republic of Ireland. Tesco Personal Finance, in which the Group owns a 50% joint venture share, has commitments, described in its own financial statements as at 31 December 2004, of formal standby facilities, credit lines and other commitments to lend, totalling £5.2bn (2004 – £4.6bn). The amount is intended to provide an indication of the volume of business transacted and not of the underlying Credit or other risks. There are a number of contingent liabilities that arise in the normal course of business which if realised are not expected to result in a material liability to the Group.
Appendix 2
Tesco’s internal employee pension literature:
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