The ‘New Normal’: Five Years on Since Lehman’s Collapse

This shift to a new funding landscape since 2008 has
resulted in the risk appetites of companies and traditional lenders diverging.
Treasuries have come up against higher costs of borrowing as well as a reduced
availability of traditional lenders, which has resulted in bank funding
becoming increasingly difficult to secure. Although this divergence is a major
issue in itself, a separate source of concern is the heightened scrutiny
directed at the decisions of the individual treasurer by various stakeholders,
including shareholders, management, regulators and banks themselves.

With this new lending landscape as a backdrop, corporates held on to cash and
reduced their risk appetites as they looked to strengthen their balance sheets
and minimise exposure to funding shortfalls left behind by traditional lending
sources. In addition, banks reduced their lending, which resulted in bank debt
appearing less secure, more expensive and generally less certain than before
the financial crisis.

This changing landscape meant that corporates
started to look to equity rather than debt when it came to structuring the
capital within their businesses. Increasingly, treasuries turned to the capital
markets to maintain liquidity and alternative forms of financing – such as
shadow, or off-balance sheet, financing – increased in popularity. Since 2008,
on the occasions where banks have made financing available to corporates, it
has been extended on tighter terms and conditions; requiring more restrictive
covenants and more specific representations.

In contrast, capital
market financing offers businesses more flexibility and freedom to operate due
to a lack of controls over the use to which the funds may be put. Although
alternative financing sources may offer treasuries more freedom and less
restrictive funding, they are still higher risk than traditional bank lending.
This is mainly due to the existing lower level of regulation imposed on
alternative financing institutions, meaning that such entities are not required
to keep the same level of financial reserves relative to their market exposure
as that required of traditional banks.

Regulation and
recommendations

Domestic and international regulation of
the financial sector is one significant area of change following the financial
crisis. Many jurisdictions have reformed their regulatory bodies in order to
prevent the recurrence of perceived regulatory failings which took place in the
run up to the collapse of Lehman Brothers. In addition to the new and increased
levels of regulation already put in place, the UK Financial Stability Board
(FSB) has published policy recommendations to strengthen the oversight and
regulation of the shadow banking system. This shows an intention by regulators
to subject alternative sources of financing to a higher level of regulation,
increasing the level of scrutiny over such funding.

The continued
increase in regulation also means that company decision makers and their
actions are under extra scrutiny from regulators. Several government and
regulatory entities, most notably in the UK and the US, have shown an intention
to hold senior management personally accountable for their actions. If the UK’s
Financial Conduct Authority (FCA) investigates a firm, it is likely to look at
the conduct of company management as part of the review. Similarly, in the US
the Securities and Exchange Commission (SEC) has announced that it will seek to
extract admissions of wrongdoing from individuals as a prerequisite to settling
a case against a company.

This change in attitude of the regulators
is partly due to public frustration around the lack of accountability following
the financial crisis. The public, including company shareholders, want to see
that action is being taken by governments; both to hold company management
accountable for failings and to prevent a recurrence of the events that led to
the financial crisis. As a result, there is a heightened level of scrutiny of
company decision makers from all stakeholders, including shareholders, company
management, regulators and the general public.

A heightened level of
regulation, alongside an increase in the number of enforcement actions and a
rise in shareholder and public interest, has resulted in company decision
makers facing an increased risk of claims being brought against them as a
result of the decisions they take. For example, as well as the risk of
individuals being held to account by regulators, where a shareholder does not
agree with the approach taken regarding the level or means of financing, the
treasurer and/or board of directors of the company could face personal
liability for those decisions. The personal cost of such claims or
investigations being brought against an individual can be huge. In addition,
the company itself can incur great expense when responding to, or defending,
claims and investigations.

With the post-Lehman Brothers lending
backdrop, the conflict in risk appetites of corporates and lenders and the
consequent shift towards the capital markets for financing, treasurers have had
to assess the risks involved in equity financing against the possible risk of
insufficient liquidity on the balance sheet due to lack of availability, or the
expense, of traditional bank lending. Increased levels of regulation coupled
with additional interest being shown by various stakeholders, has resulted in
the decisions of senior management being subject to more scrutiny from an
increasing number of interested parties.

In this landscape of lower
risk appetites, use of alternative financing and increase in scrutiny of
liquidity management, it is crucial that treasurers and other company decision
makers get comfort that there are sufficient company indemnification and/or
risk transfer mechanisms available to them. The level, and scope, of relevant
insurance should be reviewed in light of this changing risk landscape to ensure
that the treasurer and board of directors are appropriately protected from the
cost of claims being brought against them for the decisions and acts taken on
behalf of the company. Without such protection, their personal assets could be
at risk should a claim or investigation be brought against them.

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