State-of-the-art financial risk management at Türk Telekom
Türk Telekom, with 175 years of history, is the first integrated telecommunications company in Turkey. Due to its long-term foreign currency funding structure, Türk Telekom has significant foreign exchange exposures.
This initial situation, as well as several other factors, led Türk Telekom Treasury to embark on a Financial Risk Management (FRM) Transformation Project, which recently received industry-wide recognition as well as an Adam Smith Award.
As the country’s ‘Quadruple Player’, Türk Telekom offers a complete range of mobile, fixed voice, broadband, and TV services. With the vision of introducing new technologies and accelerating Turkey’s transformation into a true ‘knowledge society’, it offers services to over 38 million subscribers. Türk Telekom provides the information technologies that drive sustainable economic growth and community development. By investing heavily in fiber and mobile networks, Türk Telecom provides people with access to knowledge that, due to economic, social or physical reasons, may otherwise not be a part of this community. As such, Türk Telekom is truly a leading company in Turkey. Türk Telecom split its ownership after its privatization in 2005 and initial public offering in 2008: 15% free float on the Borsa Istanbul, 55% owned by Oger Telecom, and 30% owned by Turkish Government.
Türk Telekom is exposed to material foreign exchange exposures due to its sizeable long-term foreign currency funding portfolio, denominated primarily in EUR and USD. Due to insufficient long-term Turkish lira liquidity in the domestic debt market and the high Turkish lira interest cost, access to foreign currency denominated funding is essential for the company.
“A formalized risk management policy was still missing”
However, this simultaneously exposes the company to foreign currency risk because adverse foreign currency movements inflate Türk Telekom’s debt position and interest expenses significantly. In turn, this detrimentally effects the company’s overall financial position, credit profile, and ability to raise future liquidity to fund its large CAPEX program.
“Türk Telekom had established a number of internal mechanisms to manage foreign currency risk, but a formalized risk management policy was still missing,” says Salih Fatih Günes, Director of Treasury, Türk Telekom. This was the starting point to define the scope and objectives of the Financial Risk Management Transformation Project in collaboration with the Enterprise Risk Management department.
The figure above summarises the initial situation and subsequent drivers of the (FRM) Transformation Project.
Türk Telekom decided to embark on a FRM Transformation Project, with the ambitious goal to create an ‘integrated’ and ‘holistic’ solution across the various risk relevant categories: market risk, credit risk towards financial counterparties, and overall company liquidity risk.
“The project was seen as an opportunity to implement best market practices and benefit from outside expertise”
Salih Fatih Günes: “The project was seen as an opportunity to implement best market practices and benefit from outside expertise.” Given the complexity and involvement of multiple stakeholders, Türk Telekom required a multistage approach, each with distinct pre-defined deliverables.
Türk Telekom invited a limited number of consulting firms to respond to their request for proposal. Salih Fatih Günes:” We specifically wanted to work with a consulting boutique specialized in treasury and risk management.” Zanders translated Türk Telekom’s requirements into the tailored project approach, as shown in figure 2.
Zanders delivered a state-of-the-art risk quantification tool, tailor made to capture Türk Telekom’s ‘risk bearing capacity’ in relation to its financial profile. The tool captures financial position data, relevant market risk variables (FX, interest), and appropriate risk models, and incorporates further customized stress, scenario, and simulation tests, including an at risk methodology that uses Monte Carlo simulation.
It provides Türk Telekom with 5-year, forward-looking management information, which Türk Telekom uses to decode signals of adverse events at an early stage through key risk indicators and management consults to proactively steer the company’s credit profile. Türk Telecom based the tool on the overall financial strength and risk bearing capacity of the company as the central metrics to set risk limits and bandwidths linked to the outcome of the calculated financial risks.
“In practice it is quite challenging to deal with multiple interlinked financial risks in a holistic manner”
In addition, Türk Telekom drafted a new Group Financial Risk Management Policy. This policy incorporates strategic and operational guidelines for Türk Telekom’s Financial Risk Management activities and clearly describes the key FRM principles and objectives, steering both strategic and operational decision-making. The new policy clearly states primary and secondary risk management objectives, with liquidity risk the key risk that other risk categories align to and resulting actions derive from.
As Salih Fatih Günes states, “developing a state-of-the- art holistic risk quantification model along with new treasury policies, procedures, strategy, and governance is quite unique. In theory, it may sound straightforward, but in practice it is quite difficult to deal with multiple interlinked financial risks in a holistic manner.” Next to the industry recognition and Adam Smith Award, the project also improved internal visibility and recognition of treasury’s added value by senior management and other corporate functions.
Salih Fatih Günes concludes: “We have achieved this project in close cooperation with our consulting partner Zanders. It added value with its outside-in views, knowledge of best practice and especially with its pragmatic approach to delivering a concept into a practical, tailor-made solution.”
Best practices and innovation
Türk Telekom Treasury received an Adam Smith Award as a highly commended winner in the Best Foreign Exchange Solution category.The award recognized the following best practices and innovations:
- A holistic approach towards risk management incorporating different risk categories;
- Use of a sophisticated, state-of-the-art risk quantification tool;
- The incorporation of a risk decision-support tool in which long-term funding/rating criteria are the main drivers;
- Joint effort between Treasury function and the Enterprise Risk Management function
- Adoption of a Monte Carlo simulation model.