In the July Chief Executive update I wrote that ‘current market developments do suggest that treasurers and corporate financiers may be in for an interesting summer’. Well, for all those who have not spent the past month at the beach or up a mountain August has indeed been an interesting month to be in the City.
Whilst the pages of the Financial Times and the Economist have been seasonally low on advertising, the news and editorial content has been positively fizzing. At the ACT we’ve been watching the development of the ‘crisis’ as best we can and – at the time of writing – my feeling is that what I am seeing is not all doom or gloom. That hint of optimism needs one immediate qualification: not all doom or gloom unless you are a private equity investor beginning to question how out-performance can be sustained at a time when underlying commercial profitability may be coming under increasing pressure; or a banker that has over-zealously committed to transactional funding and now finding the sell-down process a tad challenging.
What is clear, at least at present, is that for well managed corporates with business and markets that do not face exceptional stress funding availability is not proving to be a problem. These have in place adequate committed bank facilities, in line with good and prudent treasury management. Despite the less considered analysis and comment in much of the media, the corporate CP markets continue to operate, albeit that spreads have risen somewhat.
The huge flexibility of the international capital markets provides great benefits for the treasurer, but in times like the present it does mean that there will be some inevitable contagion between markets. Credit exposures to the US sub prime mortgage market will have been packaged up and on-sold around the globe, with any actual failures having magnified effects in threatening a series of holders of the same risk (or at least putting a strain on liquidity). Within individual markets exceptional volatility is inevitable when participants are thin on the ground.
Treasurers basking in the rewards of prudence and diversification should not be too complacent. There must be a risk that a single event – almost certainly involving the destabilisation of a major (rather than peripheral) financial institution and following on from a failure of the authorities to handle the situation tidily – leads to a profound loss of confidence and stability. In this doomsday eventuality the skills of treasurers will indeed be tested.
In the meantime – and with more optimism – it is worth looking at the lessons of what has been happening. Firstly, I think it is right to be reminded that in good open markets volatility is just a normal market process – and volatility of course creates market opportunities. Secondly, excessive reliance on VaR (Value at Risk) models is patently imprudent, as some have been diligently pointing out over the years; interpretation of VaR starts from assumptions about normal rather than ‘long tail’ events. Whereas it is the latter that wreak havoc with value. Thirdly, regulators should beware of any knee jerk reaction to introduce more new regulation. The ACT strongly supports good local (national) market regulation; we favour harmonisation where possible. After mature reflection – after any panic is over – some regulatory adjustments may be needed. But it is essential, however, to guard against ill thought out regulation serving as a political gesture to satisfy pressures from those remote from the main markets affected. The example of Sarbanes-Oxley is always there to remind us of the shortcomings of a rushed, political initiative.
Looking to the future the experience of this summer’s markets should be an encouragement to corporates to take stock of their risk management policies and processes, particularly with respect to funding and credit. Just like the underlying markets these should be seen as dynamic and open to learning; for well managed companies there will still be some lessons from surveying whatever wreckage may be around after the summer’s storms.
