Low interest rate environments (or Debt: Double or Quits)

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leverageWhat a doozy of a global environment we live in. A highly leveraged society is now being asked to lever up again so that we can maintain perpetual growth. Perpetual growth is something that is unobservable in the natural world/universe – just something for you to consider.

Low (and negative) interest rate environments are supposed to stimulate growth through encouraging new or additional leverage. Nothing necessarily wrong with that (unless you’re a fixed income investor) but it does introduce a new spectrum of risk. That risk is exacerbated by the fact that developed, and developing, societies are currently burdened with a surfeit of debt.

Banks have long been required to have certain risk management protocols in place because of the highly-leveraged nature of their activities. These are referred to as Basel I, II & III (we get a new one after every major crisis to try and avoid a repeat). The current set (Basel III) introduces many features that would be well adopted by non-banking businesses, especially if their leverage increases in these days of cheap money. Companies with any amount of leverage should introduce internal capital adequacy, funding & liquidity and market risk metrics to identify, measure and manage risks related to their various exposures. Obviously, this should be on top of (i.e. incorporated into) their existing ERM framework that addresses their specific risk appetite, business strategy, industry exposure and operational issues.

These are some complex risk exposures that may not seem significant to your business in terms of probability of occurring or relevant to your industry. However, the consequences make it a worthwhile proposition (see footnote). With the right tools, you can even enhance your strategic management and decision making, gaining a new awareness of your business.

Morpho Advisory can help your business implement risk identification, measurement and management processes for your capital, market, liquidity & funding risks.

 

Footnote: In the picture above, imagine that P = debt, F = equity, and W = your business. Everything is working well until something causes the energy behind the force of debt to reduce or stop, resulting in a swing back the other way. Result: Your business crashes to the ground destroying your equity. Quantify your exposure to these external forces and develop processes to identify, measure and manage these risks!

Treasury consulting and Virtual Treasurer service

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treasury graphic

Morpho Advisory was set up to offer treasury consulting and virtual treasurer services, both here in New Zealand, or abroad.

The business world is increasingly aware of capital, market, funding & liquidity, credit and investment risks. Companies are expected to have dedicated risk management frameworks that specify risk appetite and detail how these risks are to be managed. This is not just for regulatory and IFRS compliance, but to avoid potential losses and to attract investment. It is ‘best practice’.

Only the largest companies can afford to employ the required skill to operate front, middle and back office functions. Nevertheless, most companies, especially SMEs, have a material exposure to these risks. Many businesses address their obvious exposures (e.g. FX risk for importers and exporters) but only do so in a rudimentary fashion. They do not have a risk management framework, treasury policy or hedging strategy. Nor do they have specialist skills to manage this risk or systems to measure their exposures. This problem will only be exacerbated with the new IFRS requirements for fair value measurement (IFRS 13) and financial instruments (IFRS 9).

Morpho Advisory can assist your business to address these short-falls and fill the gaps in your market risk management, compliance and governance. You can engage Morpho Advisory as your virtual treasurer, treasury adviser or market risk consultant.

It is surprising how little discussion around credit valuation adjustment (CVA), debit valuation adjustment (DVA) and funding valuation adjustment (FVA) there has been in the local market. These are real issues for all businesses with market exposures that comply with IFRS. They are technically complex matters requiring the ability to calculate probability of default (PD), exposure at default (EAD) and loss-given-default (LGD). You also need an understanding of how to price credit risk and financial instruments. The larger accounting firms (e.g. the big 4 and firms of that magnitude) may have the staff to address these issues, but most wouldn’t. At some stage businesses are going to have to engage skills to develop internal processes and systems to meet these obligations. Engage Morpho Advisory and stay ahead of the competition.