Agile, shared growth approach to managing risk in the current volatile market

Companies have been faced with myriad challenges this year. Weak economic conditions arising from slower growth, rising inflation, power constraints accompanied by increasing electricity prices, slumping commodity prices and volatile financial markets have been leading drivers for the current demanding environment. Heightened global risk aversion – a result of the anticipated increase in US interest rates – as well as the impact of weak Chinese data has played a significant impact on emerging markets and weakened the South African rand.

South African companies are nervous about how these factors will impact both the country and the future of their businesses. Many are taking prudent steps to navigate rough waters.

A number of companies are hedging their currency risk on a short-term basis and managing their exposures very tightly. Importers are constantly reviewing their risk management policies against committed budget rates, which, in some cases, are underwater. Companies that have large foreign currency and/or floating-rate liabilities are looking for solutions to mitigate this risk and lower their effective cost of funding. It feels like a perfect storm that will require corporate treasurers and their banking partners to be forward-looking, agile and strategic.

We have reached an inflection point and, given economic conditions, global market uncertainty and volatility, corporate treasurers need a robust and dynamic risk management strategy. This necessitates a policy framework with strong governance and clear mandates with specific risk thresholds that afford treasurers greater flexibility in managing various risk exposures.

Adopt an appropriate, formal hedging policy
The aggressive volatility in the markets over the past few years has highlighted the importance of ensuring any hedging policy is current and fit for purpose. There is not a single approach that forms an ideal hedging strategy, as each product has the ability to outperform depending on the evolution of foreign exchange, rates and commodity prices.

At Absa Corporate and Investment Banking (CIB), we believe a portfolio approach to hedging is prudent as it caters for a combination of outcomes. The hedging alternatives that will be covered over the course of the day can provide a diversified approach, if combined, and can be skewed in terms of percentages that align to the client’s in-house view of the price of evolution of forex, rates and commodities.

Having a formal written hedging policy approved by the board provides the assurance that the business will have adequate protection in place against adverse market moves. In addition, the treasury team has the backing to execute hedges within known parameters on an ongoing basis, and is therefore in a position to quickly respond to market adjustments and opportunities.

The hedging policy itself does not need to be a large document. The aims and parameters of a company’s risk management strategy can be outlined simply on as little as one page. However, successful hedging policies often encompass two core values: discipline and flexibility. Discipline involves a minimum level of cover, defined by both percentage of requirement and tenor, and explicit frequency of review. Flexibility, meanwhile, is the ability to choose hedge timing and products based on market conditions.

There are numerous strategies that can be adopted. However, the most effective solutions are tailored to the company’s needs.

Consider regulatory requirements
Further considerations include the cost of hedging, which has increased significantly as a result of both market risk factors, as well as counterparty credit risk. The latter is driven by regulations such as Basel III, which requires banks to hold additional capital against derivative exposures. This means pricing on long-dated derivatives becomes more punitive.

As the regulatory landscape evolves, we continue to develop solutions that help mitigate these costs through various financial instruments. However, there is an opportunity for companies and banks to work together with regulators in developing the approach and application of the different methodologies that underpin these regulations.

Look towards shared growth
The new year will bring new challenges, therefore the approach to managing risk needs to be more holistic. Enterprise risk management (ERM) is becoming more relevant, especially for companies that want to understand the broad range of risks that create complexities in their organisations. ERM is a valuable risk-based approach to identifying risks and opportunities and helps form an execution strategy.

For companies to be successful and improve exponentially, however, creating shared growth must be at the forefront of their respective mind-sets. Tough economic conditions generally mean financial institutions become more conservative around risk. However, if we applied shared-value thinking and the concept of risk-sharing more broadly, we can find sustainable solutions to existing problems.

A great example of creating shared growth can be seen at General Electric. Executives realised the challenges of global health represented one of the company’s greatest opportunities for growth in the coming years. The business is investing $6 billion to develop new, inexpensive products and treatments that meet the health needs of low-income populations around the world, with a goal of reaching 100 million new patients every year.

Engage a strong banking partner
At Absa CIB, our approach is to understand our clients’ business and risk profiles and to solve their challenges by providing solutions and products that are tailored to their needs. We wish to create sustainable value and, ultimately, enable our clients to grow.

Off-the-shelf products are not suitable or relevant in the current environment. Our focus is therefore on innovation through knowledge, transparency and simplicity, and leveraging data holistically to mitigate risk across our clients’ value chains.

We couple our knowledge of local markets with our product capability and access to offshore markets. Absa CIB has also been proactively engaging clients through numerous workshops and training sessions over the past few years. The aim of these sessions has been to ensure a mutual understanding of the impact of regulations and to partner with our clients to navigate these changes together.

As a result of this client-centric approach, Absa CIB was recently named the top overall bank in the Risk South Africa Rankings 2015 survey for the sixth consecutive year. We were also placed first in overall interest rate products, overall foreign exchange products and overall equity products, as well as in 20 sub-categories. The awards are based on the votes of dealers, brokers, corporates and asset managers in South Africa who vote for their top dealers. The achievement is testament of the trusted partnerships we have established with our clients.

About Absa Corporate and Investment Banking
Absa Bank Limited (Absa Bank) is a wholly owned subsidiary of Barclays Africa Group Limited and a major global financial services provider in Africa with regional expertise and an extensive, well-established local presence.

Our Corporate and Investment Banking division is one of the few investment banks in the country that is able to leverage an extensive global network to provide a full suite of financing, investment and advisory solutions. Our approach is supported by products and services, access to world-class technology and product expertise, as well as a strong balance sheet through Barclays Africa and Barclays plc. Our intimate knowledge of local market dynamics ensures that our solutions are appropriate and competitive within sub-Saharan Africa. Our key differentiators are:

Commitment – We have a proven appetite and ability to invest in key African markets and it is our vision to build on our leadership in Africa.

Historic presence – Having spent 100 years in the region, Absa is a ‘local bank’, with in-depth knowledge of local regulation, legal requirements, market practice and the economic backdrop.

Distribution network – One of the largest in Africa, serving many clients. This is a key factor in our ability to fund in local currencies and serve wide geographic areas.

Recognition – Absa is one of the most respected banks in Africa. We regularly win prestigious awards, recognising our standing as a leading bank for customer service and product quality.

 

About the author
Saloshni Pillay (pictured) was appointed head of Absa’s risk solutions group in 2011 and commodities and FX distribution (South Africa) in 2014.

Corporate distribution is the main point of contact for all risk management issues affecting the South African corporate client base and she regularly interacts with partners in the bank’s Corporate and Investment Banking (CIB) division, as well as the Lending and Advisory divisions on transactions that involve/require risk management. The team covers a wide range of products that include interest rates, foreign exchange, forex options, structured forex and commodities.

Prior to joining Absa CIB, Saloshni held various roles at different investment banks. She started her career at Standard Bank in 1995 on the forex dealing desk. Prior to joining CIB, she spent 10 years at Citibank covering forex derivatives, money market and interest rate derivative products.

Saloshni graduated with a Bachelor of Commerce degree, specialising in economics, from the University of South Africa. She has attended a number of professional courses, mainly in advanced derivatives and risk management. Saloshni is a non-executive director of Absa Securities Company Limited.

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