Is there a perfect storm in the making? We’re facing political uncertainty, conflicting financial figures on economic growth and employment, and a future landscape which looks less clear the more we try to map it.
Is this the time for treasury departments to step up? Often undervalued, treasury departments become the board’s go-to resource when things go wrong. Those C-suite finance officers who monitor the variables affecting their risk assessment are the ones who can stay ahead of the game and protect profitability.
Currently, global politics blends the confusion fostered by the Trump administration in trade negotiations and the reaction from both neighbours and China, with Brexit in Europe, a meltdown in the governing Liberal Party in Australia and a financial crisis in Turkey.
Add to this the hangover from the decade-old world financial crisis and alarm bells are ringing.
Economic uncertainty, as much as it can be measured, can be countercyclical moving in the opposite direction to the business cycle. Concerns about a reduction in growth mean uncertainty increases and political uncertainty impacts growth. Sounding like a perfect storm?
This is the macro-economic perspective. If policymakers send mixed messages, uncertainty grows and treasury departments must react. The lack of direction from government leads to firms delaying expenditure and slowing down the economy.
When boards turn to treasury in these circumstances the department must be ready to react with a swift risk assessment and lock in profit.
Periods of calm followed by volatility are the raison d’etre of treasury departments and this is where they prove their worth.
When prioritising issues, foreign exchange management deserves attention. Market uncertainty needs to be governed as it will impact on currency holdings. Simply watching a stock exchange rise and a currency fall, or the reverse, is one indicator of which every canny treasurer is aware.
History has shown us that political events can create extreme market conditions, Euro spot rates in 2012 in the wake of the Greek crisis being a classic example. Managing FX risk means identifying exposure across the business. The Euro crisis showed that it was not just a question of exposure to one currency but also to a country using the denomination which has consequences. Smart treasury departments were monitoring national exchanges alongside Euro trading.
Organisations exposed to this type of risk will want to reduce it by natural hedging, matching costs and revenues in the same currency, and matching revenues to funding in a single location. This reduces hedges and makes for a simple strategy.
The treasury department can shine when it is able to show that it is analysing hedging strategy with an eye on efficiency.
Just like FX markets, interest rate risks should be prioritised by treasurers in volatile times. In 2008 the tenor basis risk in the most aggressively liquid currencies hit 80 basis points impacting on the value of some financial instruments.
Treasury will want to tailor their interest rate strategy depending on the sector in which they are operating and their exposure to volatile emerging markets. It is never as simple as choosing between fixed or floating rates. Observant departments will be aware of the potential impact of cash-flows-at-risk (CFaR) and will include these in creating an action plan to deal with interest rate risk.
Depending on the sector, commodity risk may have an enormous impact on profitability. In the case of commodities, responsibility is increasingly being transferred from procurement to treasury, with good reason. Since commodity exposure can impact on risk assessments, it makes sense for treasury to take charge. The volatility of the commodities markets means CFaR can be used to understand exposure and treasury is best positioned to do this.
All the analysis suggests that a company which wishes to prosper in a volatile world economy must have a flexible risk management strategy developed alongside an understanding as to how the business is developing. Foreseeing risk is as crucial as dealing with the current situation.
This suggests that corporates should be taking a robust approach to an unexpected, what if, scenario. Forecasting cash flow, liquidity, FX and interest rate movements are all crucial. Testing the stresses on management structure will also play a part in responding to market movements.
Collins English Dictionary tells us a perfect storm is “an unusual combination of events or things that produce an unusually bad or powerful result”. As the global financial crisis showed, everyone can be affected by extreme market events whatever their approach to risk management.
Are you prepared for a change in the fiscal outlook?
Simon Lynch is the owner of Treasury Talent.
Treasury Talent is a specialist treasury talent, recruitment and search provider solely focussed on the treasury market with offices in Sydney covering Australia, Singapore covering Asia, and San Francisco covering California and the USA. To make contact firstname.lastname@example.org