Returning confidence fails to shake treasurers’ risk vigilance

By:
Rebecca Brace
Published on:

With confidence increasing in the financial system, company treasurers might be forgiven for beginning to relax the tight focus they have maintained on counterparty risk in the past few years.

According to the Bank of England’s (BoE) 2013 H2 systemic risk survey, conducted between September 23 and October 24, confidence in the UK financial system has improved, with 18% of respondents completely or very confident in the stability of the system in the next three years, and 78% fairly confident.

Indeed, the BoE survey found that: “The perceived probabilities of a high-impact event in the UK financial system over both the short and medium term continue to fall, setting new lows since the survey began in 2008.”

Some 55% of respondents consider the possibility of such an event to be low or very low in the coming 12 months, up from 50% in May.

However, that’s not to say there is nothing to be concerned about. The two main risks to the UK financial system are sovereign risk, cited by 74% of respondents, and the risk of an economic downturn, cited by 67% of respondents. Additional concerns include the low interest-rate environment, regulation/taxes, financial institution failure/distress and operational risk.

Financial institution failure or distress has been one of the chief concerns since the crisis, bringing into sharp focus counterparty or default risk. In the pre-crisis years, counterparty risk within banking relationships had been a one-way street, characterized by banks looking at their corporate clients’ credit risk.

However, since the crisis, company treasurers have been keenly aware of the possibility that any bank could collapse. Treasurers now more fully appreciate that by placing deposits with banks they were in fact lending to those banks – and that these relationships needed to be closely assessed and continually monitored to safeguard corporate cash.

As a result, treasurers have revisited their treasury policies and introduced new limits restricting which banks their companies could deposit with, and how much cash could be placed with any one bank.

In assessing counterparty risk, they have begun to look beyond the traditional measure of external credit ratings and to look at other metrics, such as credit default swap spreads, monitoring any changes in the market closely.

As one transaction banker observed, corporate treasurers have become much more proactive in analysing their counterparty risk and are doing so with more sophisticated tools and measures.

While treasurers might welcome and, indeed, share the growing confidence in the financial system, this might not be enough to have any impact on the new level of discipline they have developed in measuring and mitigating counterparty risk.

“Although the perception of declining risks is obviously welcome, I see no argument against continued vigilance,” says Rick Martin, group director, treasury and investor relations at Virgin Media.

“All too often, when times have turned positive, risk-management mechanisms can lose their vigour, and activities such as close monitoring of advance market indicators, on the ground knowledge, and diversification of cash reserves can become a bit ragged.”

Martin adds: “We continue at both Virgin Media, and Liberty Global generally, to undertake all these practices, even as we continue to invest in further profitable growth across our geographic portfolio, and a positive survey or two will not change that, welcome though it is.”

The treasurer of a technology company agrees that changes in economic conditions should not have a sizeable impact on treasury policies.

“A treasurer should use the good times to prepare for the bad ones,” he says. “Good treasury management policies are designed to use the good times to help manage through the bad ones. And they do not change when you pass from one to the other.

“In fact, the treasurer’s role is often to be the guy who takes away the punch bowl, just when the party gets going.”

The growing confidence in the financial system can only be viewed as a positive sign, but treasurers are unlikely to release their hard-won vigilance in the area of counterparty risk any time soon.

While companies might begin to revisit their investment decisions in due course, particularly if interest rates begin to rise in the next couple of years, any such moves are likely to be made with the same attention to risk that has characterized corporate treasury during the past few years.