Keep Calm and Carry On

No business needs to be told that the past year has been turbulent, characterised by economic uncertainty and political volatility that is still unresolved. Fears that more eurozone countries may need bailouts to resolve their national debt crises have choked bank lending, forcing companies to rein in funds. News that the US government has agreed a strategy to resolve its own deficit failed to reassure the markets, particularly after the world’s largest economy was downgraded in August from its prized AAA rating.

Added to these broad economic concerns, the Japanese earthquake and tsunami demonstrated the catastrophic ramifications that natural disasters can have for companies’ operational capabilities, long-distance supply chains and global customers. Then there were the political risks – instability in the Middle East and North Africa (MENA) triggered by the ‘Arab Spring’ made companies question the safety of their operations in these countries and reassess the contingencies they have in place to protect premises and staff.

It is not surprising, therefore, that this year has seen effective contingency risk management rise to the top of the corporate treasury agenda. During the first days of public protests in Egypt, for example, the Export Development Bank of Egypt (EDBE) drafted a business continuity plan so that management and staff knew what to do should they not be able to access the office or communicate with each other.

“We already had disaster centres in reserve for IT access and treasury operations. Thank goodness we had these, and that they were already tested,” says Ghada Mostafa, operational risk and information systems manager at the EDBE in Cairo. “We were able to keep the servers going and to put through some important internal and external transactions during the time the banks were closed,” he adds.

Until recently, the main focus of most corporate treasurers’ disaster and contingency risk management practices was business disruption caused by physical or IT-based threats to their part of the business, including fire and flooding. These concerns are still high on the risk agenda.

“In our highly interconnected world, we are becoming increasingly reliant on technology,” says Wilfrido Lozano, chief risk officer (CRO) at HSBC in Madrid. “From my perspective, the risks that will have the biggest impact on the corporate treasury function have to do with the likelihood of losing data, a communication breakdown, or systems failure caused by catastrophic external events such as natural disasters or terrorism. Unfortunately, we are all acutely aware that these events can severely affect not just the supply chain, but the trade cycle as a whole,” he adds.

This is why Stuart Clarke, group treasurer for the global business group at Japanese electronic company Fujitsu, argues that IT investment is key in dealing with any disruption to the company’s treasury management systems and operations. “We are fortunate that we are ahead of the curve compared with most companies because, as an IT company, we understand that technology can and should deliver resilience to protect and maintain our treasury operations, ensuring real-time data replication to remote data centres and full mobile accessibility so that the treasury department can access information from laptops or hand-held devices from any location,” he says.

This, however, is easier said than done. Clarke says there are several issues that companies need to consider when planning technology recovery for their treasury function. “Any lag in restoring operations has real economic consequences, so restoration needs to be instant,” he says. “It can be a challenge for companies to maintain dual systems consistency. The logical answer is to look to cloud-based or software-as-a-service (SaaS)-based service delivery, so this consistency is guaranteed by a specialist treasury management software provider. Disaster recovery plans without this guaranteed consistency have a fundamental weakness,” he says.

Yet, while IT remains an important consideration, organisations are also focusing increasingly on economic risks and their impact on the treasury function’s ability to deliver on its responsibilities to preserve and enhance the corporate balance sheet. In particular, organisations are analysing how such risks could affect the supply chain. “Working capital is now the key risk for corporate treasurers,” says Clarke. “Survival depends on your own liquidity as well as on liquidity within your supply chain. This is not a new concept, but its significance has heightened in the past few years.”

The Right Support

Since 2009, Fujitsu has broadened its banking relationships to match a reduced appetite for credit with its ongoing business needs. “Until 2009, we maintained around five partner banking relationships to support our customer financing activity. This has ballooned to 17 or 18 simply to continue our normal business activity,” Clarke says. “The credit crunch has probably changed forever how companies address their working capital requirements, because banks are unlikely to lend as extensively and cheaply as they did in the past. This creates pressure within supply chains, but also opens up more diverse working capital techniques that may have been overlooked as corporate tools in the past.”

Such experiences have underlined the need of companies to maintain close relationships with their banks. They must keep them informed of any changes in capital requirements to ensure they can accommodate requests for extra credit. And there are encouraging signs. In the second quarter of this year, the UK’s biggest banks increased their lending to UK companies, bringing them back on track to hit government targets. New loans totalled £53bn, according to the Bank of England (BofE), an increase from £47.3bn in the previous quarter.

However, while developing and maintaining closer relations with banking partners is vital, executives at leading global industrial companies also believe that the best defence against risk is to hold enough cash to weather any period of reduced lending potential.
The US’ largest conglomerate General Electric (GE), for example, has more than doubled the amount of cash it holds to US$91bn since the financial crisis began. “The biggest thing anybody could do is just have a lot of liquidity and be prepared for disruption, whatever its source,” says Keith Sherin, the company’s vice chairman and chief financial officer(CFO).

Diversified US manufacturer Eaton Corp, which makes truck transmissions and electrical products, has also increased its cash holdings to ensure it can cope with a potential liquidity crisis – a strategy that worked when the financial crisis first hit in 2008-09. The company says it had US$282m in cash and US$601m in short-term investments at the end of the second quarter of 2011. “We always think the most fundamental risk is a liquidity risk. You have to ensure you have prophylactic devices in place that allow you to withstand six-, nine- or 12-month periods of liquidity risk,” says Sandy Cutler, Eaton’s chief executive officer (CEO).

As well as holding onto their own cash, some companies are also reducing risk by helping to prop up the finances of key suppliers. This often involves arranging with a banking partner to extend credit to companies in their supply chain, helping keep them afloat and ensuring their own operations are not disrupted by supply problems.

“While companies are considering their own liquidity and re preserving cash, they must also consider the financial health of the companies from which they source materials or services. If these go down, it can be a struggle to find a replacement. Suddenly your company is at risk despite being profitable and liquid,” Clarke points out.

Lozano has also encountered more corporate treasurers who say the most difficult risks they face are those of supply chain failure and insufficient working capital if a disaster strikes. “The planning and management of working capital is on every treasurer’s mind and the risk of disruption is a big concern,” he says.

“One way to mitigate this risk is to incorporate better, more refined and more robust stress scenarios into the analysis. This requires treasury functions to develop new methodologies to identify emerging risks and to get a better understanding about how different variables interact with each other – for example, how macro economic, business and risk variables interact, and the extent to which these may affect your supply chain. This could help treasurers to enhance their decision-making processes,” he says.

The regulatory environment is also a concern for the treasurers he meets. Current regulatory changes are, of course, often bound up with ongoing economic concerns about economies in the Eurozone – something his customers in Spain do not need to be reminded about.

Eyes Wide Open

“We need to be vigilant about the potential negative effects of changes in regulations on key elements in the value chain, including customers and suppliers,” Lozano says. “For instance, banks and non-financial institutions that are faced with severe capital restrictions will face consequences to their supply of credit. The economic outlook and the risk of debt contagion in the eurozone is another serious issue that corporate treasurers need to consider, because, as we have witnessed recently, this can significantly affect market and liquidity conditions,” he adds.

He believes that to identify and mitigate these risks, treasurers must underpin their planning processes with stress test techniques. “The core purpose of the treasury function is to ensure sufficient and timely liquidity. Cash availability should be tested under a variety of extreme, but feasible, scenarios,” Lozano says. He says it is important to have a systematic approach to analyse emerging risks that may have a significant impact on the function’s operations, as well as making sure that technology suppliers, personnel and IT platforms are flexible and capable of coping with unexpected situations.

Peter McHugh, CEO and co-founder of enterprise risk and performance management IT provider Covalent Software, agrees that regular and robust scenario planning is one of the best tools available in risk planning. It helps to assess how an external event could affect your firm’s ability to control its income and costs.

“Scenario planning is often done as an annual one-off internal exercise involving small groups, rather than being an ongoing process,” he says. “It is too big a task to be left to one team of risk managers. Scenario planning must be carried out regularly to test whether your controls and procedures are still adequate to deal with current and emerging risks.”

There is no doubt that financial, economic and supply chain risks now dominate corporate treasurers’ risk management approaches, Lozano says. “We are now living in a different world. The challenges we face today require new and creative solutions for managing emerging risks. I believe we all need to be ready to cope permanently with the unexpected.”


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