RISK MANAGEMENT | 07 APRIL 2020 How a global crisis impacts your risk management decisions Absa | Corporate and Investment Banking > Insights and Events > How a global crisis impacts your risk management decisions Saloshni Pillay Head: Risk Solutions Group SHARE Medium to long-term sustainability will depend on the ability of businesses to manage volatile currencies and supply chain disruptions. Africa is in a precarious position as the global COVID-19 pandemic escalates. At a macro-level, financial markets across the continent have been particularly hard hit due to heightened volatility and a deterioration in liquidity conditions across various asset classes. The challenge is that this impacts every business across the value chain, which means it’s a critical factor when evaluating your risk management strategies. The knock-on effects of global supply chain challenges The disruption to global supply chains and trade has caused sizable knock-on effects in terms of how companies are thinking about cash management and liquidity. Companies are already facing a myriad of issues and decisions in terms of the sustainability of their businesses, human capital, technology and relevance. With a looming global recession, companies are in a tailspin around all these factors. Key considerations in the short-term are how companies will approach and formulate their risk management decisions. It is going to be critical for companies and financial institutions to work together to navigate this crisis. Foreign exchange, interest rates and commodity hedging considerations may take a back seat in this environment, as the focus is on short-term cash liquidity and funding requirements. However, there are also considerations around the extreme financial market movements that we are seeing in oil prices and Emerging Market currencies. The South African Rand and Nigerian Naira have been particularly hard hit. The South African Rand has traded as high as 19.35, its worse level ever and equates to a 28% depreciation against the USD since beginning of the year. This is largely due to the COVID-19 pandemic and the sovereign downgrades by Moody’s and Fitch, resulting in a significant outflow from the SA Bond market. Realities on the ground The rapid deterioration in the local currency has added considerable pressure on import sectors in SA, as costs have blown out significantly, even though we benefit from lower oil prices. The second-round effects of the pandemic on SA exports are still being calculated, however it is likely to also have some adverse impact in certain sectors given slowdown in the global economy. Further north, Fitch downgraded Nigeria’s rating to B citing ‘aggravation of ongoing pressures on Nigeria's external finances following the recent slump in oil prices and the pandemic shock’. The Naira is at serious risk of further devaluation especially given that the budget was cut by 14% due to lower oil revenue. The rest of the African continent will also be exposed to weak economic and fiscal conditions, rising costs, especially those countries with large USD denominated debt, and deteriorating trading environments due to global supply shocks. It is prudent to understand the financial impact that arises from these conditions sooner rather than later in order to ensure medium to long-term sustainability. Foreign exchange and commodities losses can have a significant impact on a company’s income statement and its ability to sustain day to day activities. It’s critical to analyse all risk factors Without any certainty on when the pandemic will end, companies should analyse all risk factors that will adversely affect their business in the coming weeks. It is critical to perform sensitivity analysis on all financial, liquidity and capital risks that will be impacted. Companies must remain vigilant over their hedging portfolios in terms of both the impact of financial market dislocations and reviewing risk management policies and strategies. This is unchartered territory and operating in it will be quite challenging for many companies. You will need banking relationships that not only understand the local market and regulatory environment, but can also help you understand these dynamics and how they will affect or impact your business, particularly from a financial risk perspective. For bankers, this means spending time on having an even deeper understanding of the client’s business and how the impact of the pandemic will affect it so that you can help them to develop and refine guidelines on how they can implement and execute risk management policies. Bankers will also have to recommend how clients can shape their decision-making approach when thinking about managing financial risks, especially through this crisis. Equally important in this environment, we also need to come up with tools to help companies to implement risk solutions in real time. Work with your banking partner There are financial risk nuances that a sound banking partner can assist a client with. For example, they can provide risk management solutions that offer more flexibility during periods of heightened volatility and uncertainty, while ensuring cash flow certainty. Appropriate engagement with Regulators is crucial during this time given the nature of possible solutions, cash flow management and cognisance of financial market conditions. We appreciate that every client is different in terms of their needs, decision-making approach and risk factors. Solutions are bespoke and targeted in terms of the client’s requirements and the markets they operate in. Absa is spending more time educating clients on how to manage underlying credit exposures, how they can source liquidity and how to mitigate financial risk costs and make it more efficient for them in managing their balance sheets and income statements. In so doing, we are helping clients to make informed decisions which invariably mitigate the potential financial risks they may face as they run their businesses. 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