Published: May 01, 2014
It was the middle of the night and as RMS Titanic floated through the North Atlantic, ladies and gentlemen, elegantly dressed, sat in the lounge drinking champagne without a care in the world. The iceberg didn’t come as a complete surprise; the captain knew they were in dangerous waters, the crew was watching for ice, but everyone thought that the ship could take it. Yet when the iceberg hit, the ship was torn apart, and the glitz and jewels of that night, April 14 1912, sank to the bottom of the sea.
It can be tempting to see our corporate enterprises as the White Star Line of Boston Packets saw RMS Titanic: masterfully structured, intricately protected (be it by financial instruments or inch-thick steel), big enough to survive even the largest problems that might come its way. Yet when struck by the iceberg of frozen liquidity, a corporation too can sink, and the 2008 recession brought the chill of that iceberg to the decks of many a company. But while Captain Smith relied on reports from the lookout, with little information about structure of the ship, we can use centralised treasury information, technology and processes to fully understand our liquidity today and tomorrow – and avoid disaster.
You shouldn’t need to be warned that we are currently in dangerous waters, and indeed we have been for the last 30 years or so. Globally, we’ve been through one crisis after another: the Latin American debt crisis of the 80s which resulted in such a liquidity crunch that entire nations (Brazil and Mexico) ended up defaulting; the ‘87 ‘Black Monday’ stock market crash which dropped the Dow Jones by 22.61%; the Japanese asset price bubble from 1986-1991, which saw stock prices plummeting to half of what they were at its peak; the US savings and loan crisis; then the dot com collapse. Not to mention numerous national/regional crises.
Due to the evolving global market economy, increased trade relationships, and the advance of global capital, the impact of these crises has increased in severity, making it more challenging to navigate and find a safer financial route for corporations.
Then 2008 hit. If the last 30 years were troubled waters, 2008 was the sudden drop in temperature on the night of the impact. There were a multitude of financial effects: FX fluctuations, commodity rate fluctuations, etc. all which can have significant impact on the bottom line, but they will hardly sink the ship. What hit hard during the financial crisis was the limiting of bank loans, which before were relatively easy to access and fairly inexpensive. In most cases bank loans could be provided but now with a much higher cost of funding, especially due to increasing risk adjusted premiums. Today’s treasury departments need to incorporate the future potential risk premium in interest yield curves – and eventually shortages in liquidity – when they perform scenario analysis.
Like an iceberg in the ocean at night, these problems can be hard to foresee. For some they come in the form of changing markets, restricted borrowing, or even sometimes something as innocent looking as a contract provision.
The latest financial crisis also showed the impact that loan documentation clauses such as ‘material adverse change’, ‘cross default’ and ‘negative pledge’ could have, quickly becoming problems for both parties. Sure, they were meant to protect against placing any one lender in advantageous situation over another, but they also caused very quick and uncontrollable situations for companies in a market that didn’t behave ’normally’ – restricting control of a company’s liquidity.
So how do we know when we have a ’material adverse change’, especially for an undrawn Revolving Credit Facility? When one debt cross-defaults, suddenly the house of cards falls. A negative pledge prohibits any collaterised borrowing – unless exempt assets have been clearly defined. Other covenants may protect lenders, but we should ask ourselves if these covenants aren’t a devil in disguise for both parties, especially given the potential for future financial crises.
As a treasurer, you should ask yourself:
These questions are especially important if you have a global organisation with full or partly decentralised borrowing mandates.[[[PAGE]]]
There is a reason why liquidity risk management is a significant risk factor on which many corporations are focusing their attention: there is a real need to improve cash visibility and optimise centralised group liquidity forecasting. To do this, you need all players involved. You can control outgoing payments (A/P) by establishing group wide policies, implement and educate about group-wide liquidity forecasting guidelines, and ultimately optimise working capital. But to do this, you need to be able to dive into your actual financial status, not just your reports.
One needs the right tools. Excel is good, but most companies are already stretching it to its limits. To really understand the structure of your liquidity, you should have good treasury management systems, or an even more sophisticated global treasury platform. Modern treasury platforms give you the means to this, but not always the ends. Companies frequently buy treasury systems and then fail to incorporate them across all subsidiaries. Licences are too expensive or implementations too gruelling to allow everyone to have access, so instead headquarters will selectively choose which subsidiaries are involved, if any. But this results in haphazard data, supported by the same old reports. Companies need to roll out global solutions across all subsidiaries, providing real data, giving chiefs the ability to see the details and the contexts of their enterprises, not just look at reports from the lookout.
When in troubled waters, it is essential that companies centralise their treasury information and processes in order to fully understand their global financial situation. To do this they need reliable, detailed information, the type that comes from actual financial analysis, not just reporting. Without this kind of treasury in place, we must expect at least a few more Titanics in 2014.
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