What a week… If you joined our first Playbook Live event on Thursday, thank you. It was so much fun. The feedback was incredible, so I’ll be doing more of those, and I’ll make sure they only get better.

We’re in the middle of the CFO Super Bowl… Q3 earnings out, budgets to finalize for next year, and the last few weeks of this year still to land. Exactly the kind of pressure and plate juggling a boardroom savant like you was born for. Go get ’em, tiger…

Meanwhile, back to this month’s Playbook series: The CFO’s Guide to Corporate Treasury:

BUT… before we get into it, a word from our friends at Airwallex, who know a thing or two (about a thing or two) about Treasury…

Expanding into new markets is fun. New challenges, new customers, and … new currency risks.

Getting that last one right sits firmly on your desk, my CFO friend. And alongside the risk, there’s plenty of cost and inefficiency hiding in the plumbing too.

Most of the answer sits in your banking setup.

You know the drill. Convert when money lands and again when it leaves. Turns out you’re paying twice, and you didn’t even know it.

Trust me, I’ve been there.

In Airwallex’s 2027 CFO Benchmarks, Sapio Research found 42% of the finance leaders surveyed flagged FX markups as a hidden cost of international growth.

PS - Today we’re talking treasury policy. As you think about yours, Airwallex’s report is a useful reminder to check what your currency setup is costing you, too.

Treasury teams are not supposed to be famous. Not even for one little minute.

So, when Brazilian company Aracruz Celulose booked a $2.13bn loss on currency derivatives in 2008, this was the Treasury equivalent of Taylor Swift’s sound engineer becoming the headline act…setting fire to the stage... and Taylor… at the Super Bowl halftime show.

What made it all the more extraordinary was Aracruz wasn’t an investment or financial trading operation. You see these headlines from time to time with bankers or traders who get over their skis. Taking calculated market risks is the game, so it’s bound to go wrong once in a while.

Aracruz Celulose was in the business of pulp…

Not a euphemism for pulping their reserves. Actual bleached eucalyptus pulp. They grew and harvested eucalyptus trees, converted it into pulp, and sold it overseas to paper and tissue manufacturers.

So what starts as a giant farm of eucalyptus trees ends up looking like this, ready to export…

And they were the global leader in their category, with about 26% global market share.

For context, their 2007 net revenue was ~$1.9bn and adjusted EBITDA just under $900m. Yes, you read that right… an adjusted EBITDA margin of nearly 50%.

So how the hell did they end up booking a Treasury loss bigger than an entire year’s revenue, when all they had to do was protect that delicious pulpy margin?

“Paddington, you didn’t leave the taps running, did you?”

Meanwhile…

Aracruz was a 95% export business. A substantial proportion of its costs were in Brazilian reais, while most of its revenue came in foreign currency. Mostly US dollars.

Meaning currency management was utterly fundamental to its gross margin. Get that wrong, and all your hard work controlling operating costs, harvest yields, etc. could disappear in the exchange rate.

Now, we are talking 2008 here, and you might recall there was a tickle or two in the markets around this time.

The Brazilian real whipsawed from REA:USD 1.59 in July 2008 to R$2.40 by December. A depreciation of about one-third against the dollar. With a ton of volatility in between.

For a dollar exporter, that should actually have helped the underlying business, making its Brazilian cost base more competitive.

But Aracruz had let the Treasury tail wag the dog (so hard it broke it’s neck).

The Treasury program had become far larger and more complex than a conventional currency hedge. Their contracts were leveraged, with option-like features that magnified exposure to what might have been dismissed as “tail risks.”

In other words, the paper boys and girls started playing with the wrong kind of paper. And lost BIG…

At the time, the company also disclosed that derivative exposure and potential losses ‘may have exceeded limits approved by its board.’

Um… really? YOU THINK!?

The Treasury machine had become bigger than the business it was supposed to serve. Somewhere along the way, it had decided it could be a profit center. Forgetting what the business was there to do: cut down trees and smash them into pulp.

And it was gloriously fucking profitable, which makes taking that kind of risk all the more extraordinary.

That underlying profitability helped secure a rescue into new ownership despite the monumental trading loss. And, (one would assume)… thankfully, a new Treasury team.

A few transactions later, the operation is still going today, now inside the giant Suzano group.

These days, they keep their paper bleached and don’t play with the greener stuff.

The Black Swan by Nassim Nicholas Taleb should be required reading for anybody with influence over anything. Let alone CFOs. The world has more ways to surprise you than your brain is equipped to imagine.

Tail risks happen. In the fall of 2019, not a single long-range plan would have included a scenario where a pandemic would put the world into lockdown within six months.

Then it happened.

Leicester City were famously priced at 5,000–1 to win the Premier League.

Then they won it (the bookies learned a lesson on tail risk that day.)

As Nvidia investors found out this week, mad shit happens. Predicting precisely which piece of mad shit will happen next is a fool’s errand. But the probability that some kind of mad shit will happen is spectacularly high.

Every business is exposed to forces far more powerful than itself. Treasury’s job is to help the business withstand the financial consequences.

Aracruz’s Treasury function did the equivalent of betting the house that the roulette wheel would land on anything other than zero.

Usually, you win.

But the probability of rolling zero is small, but not zero. Keep putting the house on the table, and the odds of eventually losing it climb very quickly.

Some specialist hedge funds build entire strategies around a flaw in how the rest of us think about risk. We imagine a world of neat bell curves, where extreme outcomes are vanishingly rare. But financial markets have fatter tails, creating opportunities for those who understand what the rest of us underestimate.

Treasury is an abstract concept for much of the business. Hell, even for the rest of finance. It’s not uncommon for the CFO and Treasury team themselves to be the only people who understand its true remit.

Everyone relies on it. It’s the last line of defense against all sorts of things. But you only really notice it when it stops working (like Microsoft Outlook).

So, while I’m not one for endless policies for policies’ sake, a Treasury policy is a must-have if your business has any kind of treasury complexity. Even a two-person business needs rules for how payments get sent.

The place to set those rules is the Treasury Policy.

I know, I know. Two quite boring words put together to make something even more boring-sounding. But, I promise, it is interesting when you get into it. And it’s CERTAINLY more interesting when you haven’t got one and something goes wrong.

Here’s how you might lay one out:

As a habit, a CFO should be revisiting their treasury policy (and taking it for board approval) annually, or with any major shift in risk profile.

The big, obvious risks are … well… big and obvious. But it's the buried ones that cost CFOs their jobs.

Take this example.

You’re a euro-denominated business based in the EU, buying volatile commodities from the US in dollars. The exchange rate is €0.90 to $1.

You’re also a large, decentralized organization with clear segregation of duties. Sounds like a good thing, right?

Someone in procurement negotiates a fixed euro price for the commodity. Budget certainty. Commodity volatility taken off the table. Nice work.

Except the implied exchange rate baked into that price is €0.92 to $1.

They’ve made a commodity purchasing decision. And, whether they realize it or not, an FX decision.

Meanwhile, your sales team is busy signing export deals in dollars. Those dollar receipts could have helped cover your dollar purchases. But procurement has just fixed the purchases in euros.

Then the dollar weakens to €0.88.

Your dollar sales now bring in fewer euros. Your purchases remain locked at a price incorporating €0.92.

You’ve ended up on the ass-end of both sides of the FX deal, when there was no real exposure in the first place. So much for protecting the margin. For the record, I’m not saying those decisions can’t sit with commercial teams. Just that everyone needs to be clear about the financial risks they’re taking, and the authority they have to take them.

This is why a Treasury policy needs to make abundantly clear what is, and what isn’t, a Treasury decision. Including the ones buried inside apparently ordinary commercial deals.

Its audience potentially includes anyone in the business. Because the risks reach into every corner…

Making this suuuuuuuper specific to your business is what matters.

You might decide that procurement can make commodity-risk decisions on - for example - everything except fuel. Because you’re an airline, and fuel prices are a total P&L breaker. Just like currency was for our eucalyptus friends.

For exposures like that, approval thresholds should run all the way up to the board, depending on the size and risk of the decision. If a single call can move your full-year gross margin by whole percentage points, that call belongs on the CEO’s desk.

A Treasury policy with properly enforced limits should have stopped that unnecessary financial disaster.

Zoom out further and you can think about three different sources of financial exposure: operating, balance sheet and event-driven.

Operating exposures come from recurring sales, purchases, payroll and other cash flows. These ebb and flow with the underlying economics, so you might move from a net exposure in one direction to a net exposure in the other. It’s both a giant math puzzle and a giant process challenge.

And the inputs keep changing in two places: financial markets (FX rates move, commodity prices jump) and inside the business (volumes shift, pricing changes, margins weaken). You need reliable processes to capture those changes and keep the ever-changing exposures under review.

Balance-sheet exposures are more directly financial risks, particularly on cash, debt and receivables. Maybe you were holding your cash in Silicon Valley Bank in March 2023. Or, in mid-2021, you chose a floating-rate term loan over a fixed-rate bond and decided not to swap it to fixed, just before rates took off.

These tend to be big calls made from time to time, with consequences that stick around. Again, a well-written, properly governed policy should set the boundaries for those decisions and make clear when they need revisiting.

Event-driven exposures arise from M&A, major refinancing, CapEx or other one-off cash flows. Say you operate in dollars and are about to buy a business in pounds. Sterling is bouncing around. You’re 90% sure the deal will close, but you don’t know exactly when. Hedge now, and you could be left with a currency position and no acquisition. Wait, and the price in dollars could run away from you. A tough CFO call.

Material exposures like these warrant explicit board-approved parameters and may justify exploring options or deal-contingent hedges. The protection needs to fit the uncertainty.

The challenge in a complex business is that the P&L is full of offsetting impacts. Across different line items, and in completely different parts of the business. The kinds of parts that don’t talk to each other.

Some of those offsets create genuine natural hedges. Others just happen to be moving in opposite directions.

So how to manage it?

Well, next week, we’ll get into the specific tools, but first you have to get the right approach…

You could lock everything down with a heavy-handed policy and route every decision through Treasury. But that isn’t the answer, it’s far too slow. And a great way to make yourself very unpopular.

I’ve also seen some super-clever models that try to net all those exposures down to a precise position per exposure. I.e. getting specific about what a $0.01 currency movement means net across the whole business. It’s kind of the treasury purist approach.

The process can be useful. But the output can be wrong in a great amount of detail. The business moves faster than the assumptions, so complacency is a real risk with this approach.

Then there are platforms that promise to put all your Treasury exposures into a single dashboard. But get under the hood, and they depend on a level of structured data, process discipline and compliance from the business that’s normally unrealistic to expect.

So, honestly… I don’t have a neat answer that makes all this easy.

Ultimately, there’s no substitute for really understanding the business. Knowing where the natural offsets are, what needs to remain true for them to work, and what could pull them apart. Keeping ears and eyes open through your budget process, reporting cycle, in your business reviews.

It likely means always having a few key things on your watch list. Particular currencies, commodities or the bond yield curves. But also the business assumptions underneath them: sales volumes, purchasing patterns, payment timing. Quantifying it precisely where it matters most.

This is also an area where AI could be an exciting part of the solution in the long run. Its ability to sift through huge amounts of scattered data and untangle complex relationships suggests, from first principles at least, that it could help a lot.

Of course, a lot of treasury comes down to risk appetite.

One approach I’ve always taken with Treasury is simple: do no harm.

Especially when you get into more complex Treasury products. It goes back to the idea that mad shit happens.

My default was to avoid Treasury actions that increased the business’s overall exposure to catastrophic losses. Particularly anything with open-ended downside.

For every Aracruz, there will be others that took similar risks but weren’t punished by the market gods. Some probably never realized how exposed they were.

Getting away with it doesn’t make it a good decision.

Every now and then, something complicated would land on my desk. A hedging proposal. A decision on pensions. A combination of FX and interest-rate exposure on a piece of debt.

It’s easy to get carried away with the language and the advice. My test was always the “flip chart test.”

Could I explain what we were doing, why, and what could go wrong to my board, using a marker and a single page of a flip chart?

If I couldn’t, I backed out, it was a sign I was about to play a game I didn’t understand well enough.

So if you ever find yourself CFO of a eucalyptus pulp business and your Treasury team or bank pitches a complex futures product with a low probability nasty sting in the tail, give them a metaphorical (or literal) slap.

Remind them that you already take plenty of risk growing trees and smashing them into pulp…

Treasury’s job is to protect the business you’re actually in. That starts with understanding your exposures, setting clear boundaries and making sure people follow them.

Next week, we’ll get into the practical choices for managing FX, interest rates and other financial risks. Bring a flip-chart and a marker

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🥓🔥 Stay Crispy,

Disclaimer: I am not your accountant, tax advisor, lawyer, CFO, director, or friend. Well, maybe I’m your friend, but I am not any of those other things. Everything I publish represents my opinions only, not advice. Running the finances for a company is serious business, and you should take the proper advice you need.