While this is a prosperous period for the world economy, the recent volatility in the stock markets globally is an indicator of changing times. The World Bank has forecast growth of 3.1% for 2018, which will benefit businesses, but at the same time a healthier trading environment brings with it the prospect of wage inflation, interest rate rises and the end of cheap money. As we saw from the dramatic reaction to figures that showed US wages were rising faster than expected, the markets are jittery about the end of loose monetary policy.
Besides macroeconomic developments, other significant changes are afoot. The established political order in the US and Europe is being questioned, tensions are rising again in the Middle East, technology is transforming the way we live and work, and the US is overhauling corporate taxation. Change brings opportunities, but it also presents risks.
So what are the five key risks that CFOs and treasurers should have on their radar in 2018 and how can they manage them?
Cybercrime is an ever-growing and an ever-present threat. It is a particular concern for treasurers since money is of obvious interest to cyber criminals. In 2016, research by the Association for Financial Professionals found that almost three-quarters (74%) of the organizations that it had surveyed had been the target of attempted or actual payments fraud, including check fraud and unauthorized transfers of funds associated with business email compromise attacks. Almost a third (29%) of those that had been targeted by fraudsters had lost $250,000 or more.
Additional reading: Dangers of Bad Cash Forecasts
Corporates that don’t have the right systems to detect unusual behavior and suspicious payments run the risk of their organization suffering serious reputational damage and possibly significant financial loss. Yet, the Hiscox Cyber Readiness Report 2017 found that more than half (53%) of the US, UK and German companies that were assessed for the research were ill-prepared to deal with an attack. Meanwhile, cybercrime cost the global economy over $450 billion in 2016. So CFOs and treasurers must talk to their technology vendors to make sure they are investing in the most effective security capabilities for their systems.
2. Rising interest rates and the end of cheap cash
For years, large corporates have been able to borrow money at extremely low rates. In the seven years that followed the financial crisis, US corporates were typically borrowing from banks at interest rates in the region of 3.25% while the UK corporate borrowing rate dipped as low as 2.65% in the last quarter of 2009. Meanwhile, even in December 2017, the average interest rate for a fixed bank loan of over €1 million for a period of 10 years or morewas 1.75% in the euro area, according to the European Central Bank. In the bond markets, borrowing costs plunged even lower with some companies, such as French pharmaceutical multinational Sanofi and German consumer goods producer Henkel, even managing to issue negative-yielding debt.
Now the clock is ticking on cheap money, however. The US Federal Reserve has hiked interest rates five times since December 2015 while the Bank of England announced its first hike in more than a decade in November 2017. The European Central Bank is expected to follow suit and the Bank of Japan is cutting back on its bond-buying program, suggesting that rates will rise in due course. Corporates should expect their funding costs to increase over the coming months and years, with highly leveraged businesses set to feel the biggest squeeze.
To avoid unwanted questions from the board about being penalized by the high cost of cash or a, global CFOs and treasurers will look to mitigate the risk of more expensive funding by refinancing early and for an extended period of time. They can also mitigate the risk of higher borrowing costs through effective cash management, by better utilizing global cash surplus balances to reduce short-term borrowings and, and doing thorough due diligence on M&A deals to make sure their company doesn’t overpay for an acquisition that it later regrets.
3. US tax reform
US corporate taxes were slashed to 21% from 35% with effect from 1 January 2018. What’s more, as part of the reform package, there is a one-off repatriation tax on corporate earnings held overseas (15.5% for liquid assets and 8% for illiquid assets) that is intended to encourage US companies to bring back cash they have previously stashed abroad.
On the face of it, the tax reform seems beneficial for foreign companies doing business in the US since their subsidiaries there will pay less tax. Yet some of the rules, including a base erosion and anti-abuse tax (BEAT) and a cap on the deductibility of interest, present challenges for some multinationals that have a US presence and move money in and out of the country. As a result, CFOs and treasurers will need to have greater visibility of their organization’s cash flows in and out of the US and review its strategy for intercompany loans.
Although the UK is set to leave the EU on 29 March 2019, there will almost certainly be a two-year transition to smooth its departure. During the transition, the UK will have to abide by EU rules in the same way that it does today. It is not clear what the longer-term implications of the split will be, however, since a trade deal has yet to be thrashed out. In the past, UK regulators have been highly influential in influencing EU law for financial services, but going forward, there could be a divergence between UK and European rules – for example, in terms of how the Basel capital and liquidity standards for banks are adopted.
According to PwC, the uncertainty associated with Brexit poses a number of specific challenges for treasurers, including foreign exchange volatility, possible funding shortages and increased counterparty risk if companies have to suddenly develop relationships with unfamiliar financial institutions. So it suggests that organizations put in place processes and systems that enable them to readily access their cash, monitor their treasury risks, adapt their financing strategies to changing markets, and manage their relationships with financial institutions.
5. Economic shock
So far the volatility that we’ve seen in the equity markets in 2018 can be better described as a correction rather than a crash, nevertheless a catastrophe may well lie around the corner. It is no coincidence that the fall in equity prices happens to coincide with the rise in bond yields that has come about as a result of governments buying fewer bonds. In early February, the benchmark US 10-year Treasury bond hit 2.85%, its highest point in four years, as investors pulled out of equities to invest in bonds.
The current market conditions have two significant implications for treasurers. Firstly, as the yields on government bonds rise, it will become harder for companies to issue corporate bonds with historically low coupons. Secondly, if there is a major stock market crash, this could dent consumer sentiment and cause both people and businesses to cut back on their spending, squeezing companies’ cash flow. Also, difficult market conditions may prompt banks and bond investors to refuse funding to companies that are not seen as desirable credits. Of course, it is virtually impossible for a company to buffer itself from the full impact of a major economic shock, but sound working capital management can pay a vital role in helping an organization to survive even the toughest of times.
Ready to react?
In an environment of constant flux, it is crucial to be able to respond quickly. So CFOs and treasurers who can’t capitalize on the opportunities presented by change put their organizations at risk of falling behind. Fortunately, effective cash management is a great foundation for long-term business agility, especially when it is combined with powerful technological tools such as in-house bank capabilities, notional cash pooling and payment fraud detection systems. Our client, Ohio-based plastics supplier A Schulman, is a great example of a treasury that made substantial time and resource savings, and established itself as best in class, by using cash pooling and an in-house bank to reduce bank charges, lower borrowing costs and achieve tax efficiencies.
Ultimately, change does not have to be a threat to organizations. Thanks to technology, it can be a great opportunity for them to profit and grow
Global CFOs and Treasurers Face 5 Massive Business Risks in 2018 was featured in Treasury & Risk magazine.