Economic Pulse – January

In this episode, Jeavon Lolay and Abel Martins-Alexandre discuss the high-level priorities for treasurers and CFOs as we move into 2023. 

  • Moderator: Welcome to the latest episode of our Economic Pulse series. The changing economic and financial climate presents many challenges, but it also offers the opportunity for finance professionals to enhance their standing in any organisation. As we draw the curtain on 2022, I am joined by my colleague Abel MartinsAlexandre to consider the high-level priorities for treasurers and CFOs as we face into the new year. Abel is Managing Director and Head of Infrastructure, Energy and Industrials in the Corporate and Institutional Banking division of Lloyds Banking Group. He supports our clients across the full range of commercial lending activities, risk management, capital markets, transactional banking and related advisory services. Prior to Lloyds, Abel spent fifteen years at the diversified metals and mining group Rio Tinto, including as group treasurer. As group treasurer, Abel had global responsibility for corporate finance, funding, liquidity, capital planning, structured and project finance, treasury and operations, trade finance, financial risk management, pensions, investments, insurance, pretty much everything. So, it's an absolute pleasure to have Abel with us on this latest broadcast. As an economist, Abel, I have to admit that the past year has probably been the most eventful I can recall. There's simply so many moving parts and often all moving at the same time. However even I am in awe of many of the corporate treasurers and CFOs I've been fortunate to meet this year.

    Because as for me, I simply talk about the issues such as spiraling energy prices, rising interest rates, tight labour market, supply chain, the climate change etc. but these individuals, they're required to both assess what's happening, but also take decisions at pace. So, I guess my first question to you is, with so much going on, what should be the key priorities on a treasurer's checklist?

    Abel Martins-Alexandre: Hello Jeavon, it's a pleasure to be here. As you say, I mean it's an exceptional time today. I've spent 25 years in the banking industry and today really is a time of untested territory for many of us. In particular for the younger generation who have not witnessed some of the risks that we are witnessing today. In particular, inflation and increased interest rates to the magnitude that we've seen over the recent past. I suppose though, it really starts with the basics, and coming from industry, we used to apply checklists pretty much for everything we would do and I think having a checklist for the key risks that a treasurer should be considering is actually quite useful. And it really starts with cash, right? I think it starts with making sure that you have the right amount of cash in the right location, in the right currency. It continues of course with the cash flow accuracy and to which extent you have the right systems and tools and the data to ensure that you have accurate cash flow forecast. So that then you can optimise not only the use of cash but also your liquidity. So, when it comes to liquidity management, there are really two aspects that are quite important.

    Number one is to make sure that your short-term liquidity is adequate and meets the needs of the business, but also beyond the short term, looking at the medium-term liquidity requirements and how the funding plan sits in that equation to what might be increased levels of risk in particular in regard to your operating cash flow. Now, companies right now may be holding more liquidity than before in certainly pre-COVID times. So, what's the right amount of liquidity, how much is too much, how little is too little? Do you have the right tools, data, liquidity at-risk tools to assess the right level of liquidity? And do you have the right funding plan to ensure that your uses of cash will actually be met? So, I think that's why it's important and on top of that, I mean have you accounted for a number of risks that may have an impact on your use of liquidity in the future? I've seen too many companies that have actually not accounted for risk and accordingly, not, embedded that in the funding plan. The return on cash today would be actually a key question for many treasurers given the fact that interest rates have increased. Where does that return, where does yield sit in the pecking order of priorities for the investment of cash? Alongside security of capital and alongside liquidity.

    I think that will be dependent on the risk appetite for any given treasury, not treasurers being conservative by definition. That would also depend on the amount of cash of course, the level of sophistication. The tools that they use for investing cash from bank deposits to money market firms, to repos, etc. Separately managed accounts may be another one. And also, in the capacity, I suppose, to score the risk environment in which they are. And I think having a good checklist and a good process in regard to how the risk environment is affecting precisely where the cash should be invested is actually quite useful. You know, it stems from a number of metrics that can be used from financial condition indexes to the rating of banks to CDS and other metrics. But having a clear view of the risk environment and a clear key scoring to that effect I think is quite important. By extension I think financial counterparty risk is quite important. Not only in regard to the positions that businesses would have with banks, not only the bank deposits but also in their relative positions for example, or in access to capital. But also, asset managers to the extent of treasurers running pension funds and also interest to the extent of course, of insurance policies that are in place for business interruption, property damage. Other insurance policies include also trade credit insurance. So, having a good process and good tools to assess the financial counterparty risks is absolutely part of the checklist. I will finish off with one category of risk that at times is taken for granted to be quite frank and that's operational risks. And there are really three aspects with, number one, the controls that are put into running the treasury operations and other funds processes. So, how strong are these controls? This is not the time to assume that they work perfectly, this is rather the time to make sure that they continuously improve. Cyber risk, of course, this is not new but in times of stress and uncertainty, as we are seeing today, there's an increased risk in regard to cyber, and certainly, we see it in the data. To the people side of risk, and people at the end of the day are the first line of defense and they need to be taken care of. And we need to make sure that treasurers as leaders take care of their people and are clear about that first line of defense. And are people equipped, are people in the right condition? Are people taken care of to make sure that they take care of risks essentially?

    So, that's really back to the basics, but checklists and having the discipline to go through them I think is really what treasurers should be doing right now. And we see a number of clients doing that more and more today.

    Moderator: Thank you Abel, that's very comprehensive. And I think a key point there comes to my mind is obviously the changing environment in terms of interest rates as you've touched on, and the fact that cash now is basically such an important, sort of, aspect, both in terms of obviously the yield it provides, plus the requirement in terms of obviously debt servicing. Listening to you, I can't help but think with so many, you know, factors to consider that building strategic resilience is absolutely critical, you know?

    Abel Martins-Alexandre: Yes.

    Moderator: So, how are firms achieving this?

    Abel Martins-Alexandre: Yes, I think this is really an interesting point in the sense that we talk a lot about risk and, and a number of clients of ours would not necessarily have witnessed or lived through some new risks that we are witnessing. Inflation, interest rates rising to the extent they have. And, general volatility here, I think it's quite interesting for as I mentioned before, to go through the checklist and make sure that the risks across category are well covered, as well as making sure that the financial risk management policies are still fit for purpose. One would always want to make sure that the business model is the cornerstone of how we would manage risks, rather than being opportunistic in taking risks that the business model would not otherwise cope with. But moving away from risk which is of course at core identifiable, measurable, transferable depending on how much risk appetite any business would have. Resilience is a different concept and we've talked about resilience for a number of years now. But it is different than risk. It is different than risk because it comes from a different mindset, one where you can't really measure what would impact you, the need to adapt to shocks and, and resilience is very much about adaptation to shocks and being able to pursue and continue to make your business model viable.

    As well as, you can't really trade away resilience. You can't really diversify against it, you can't really hedge against resilience. So, for me, it really starts with having business continuity plans and business recovery plans in place. And it's the case for treasurers, for CFOs, as it is the case for any other function. So, if you have a shock, an operational issue for example or cyber-attack, how do you recover from it? How prepared are you to face into these potential issues beyond the risk that you may have identified in the first place? So, business continuity plans, business recovery plans and going through the discipline of adapting, updating them and testing them is actually quite important. Another aspect that's really important is to look at the medium-term resilience of the business, rather than what risk is often looking at, which is shorter to medium term. Resilience talks more to the medium to the long term. How resilient is your business model? How resilient is your business model to climate change? To your own infrastructure, to your set of clients, to your supply chain, to the very products you actually produce, to your footprints. How resilient is that? So how do you adapt to that and prepare for what might be long-lead items is actually quite difficult and at times a difficult economic equation. But that's really part and parcel of what a number of companies are doing, and certainly in a number of roles I had in the past working in strategy and a lot with risk, going through the measures that enable a business to cope with external shocks over the medium term is part of forming resilience.

    There is a good governance framework around the long-term value of these statements that now publicly listed companies have to abide by and report on as part of their annual reporting process, which is a very useful framework. Probably succinct when it comes to annual reporting, far more detail in the working for any given strategy or risk function and where we can certainly help, also provide some details. But it is a really good discipline in looking at how a business can adapt and recover and continue to remain resilient over time. And the final point on resilience is that although it's more difficult to quantify than risk, you can apply a number of quantitative techniques to actually reverse stress test what the impact that would stem from some shocks on your business model. Business model being defined again as being in business, generating operating cash, as well as it can be to satisfy your shareholders' requirements, be it in growth or be it in shareholder returns. So, we are also of course happy to help on that front. So that's how I look at risk versus resilience. More and more we need to think about resilience, I would say.

    Moderator: Thank you, Abel. So, my takeaway from that is, as you mentioned, risk management is something that we do pretty much all the time, but resilience really is a mindset, that's what I'm hearing in a sense. It's something that you need to always have front and centre and appreciate basically how it affects the business in everything you do. I suppose perhaps unsurprisingly a lot of the focus of our conversation so far has been on risk management and resilience, given where we are in the economic cycle and the challenges. But as I mentioned at the start, there's far more on a treasurer or a CFO's agenda where we look forward, when we look back, etc. in development, so many aspects. So, do you mind just sharing with us a few of the other key aspects of these roles, and which obviously allow the opportunity for these individuals to really make a mark on the institutions?

    Abel Martins-Alexandre: That's really interesting as, for a number of years, we have been talking about the evolution of finance and treasury and I think every treasurer would want to have a seat at the table. And of course, treasury functions vary from one business to the other. But based on my experience, and that may be a link to resilience actually, the strategic side of enabling a treasurer to have the right conversations with the CFO, the board, the audit committee and the finance function also at large really stem from, number one, data. I think having a good grasp on data and using data to provide the right insights on the quality of the cash flow, accuracy and the quality of the liquidity at risk and the quality of the cash flow at risk, and the quality of course on the estimates for financial risk management practices, I think is quite essential. And as a treasurer does this actually, it enables a number of conversations around the improvement of finance processes across both sides of the balance sheet, from the P2P, the procure-to-pay process, to the contract to cash process on the receival side. So that end-to-end process is one where procurement, IT, finance as well as treasurers have a role to play to make sure that it's improved. And that's one way for treasurers to have a seat at the table. Another aspect of course relates to ESG and climate change. So, this is a strategic matter, and I would say that finance doesn't really often solve for strategy. At the same time targets for reducing emissions are essential for every business and they are essential for every bank.

    I mean, we have committed to setting up targets and that dialogue between banks and treasurers in regard to having the right baseline, having the right targets and how we can support each other and partner to make sure that we are a force for good and we reduce emissions is essential. And it stems from an increased need for treasurers to really understand what I would call the left-hand side of the balance sheet, the business model, and really understand how good a credible transition plan the business has where more and more we, and potentially other banks, would want to spend time to make sure we are part of the solution. So that really forms part of the strategic agenda. The last point I would say on that topic is, and again that comes back to resilience, resilience is not risk, it's linked to it, but the resilience of the operating model and of the business model will often stem also from having continuous access to capital in the best terms over a certain period of time. So, treasurers will need to make sure that the capital planning, capital structure, dividend policy as the case may be, keep being tested across potential shocks in the future. And in doing so they'll be part of the conversation with the risk function, with the finance function but also with other functions in regard to what might go wrong and how do you prepare and cope for satisfying the needs of shareholders and satisfying the requirements of the business model. Which go beyond being in business but also go to how do we satisfy the growth agenda, as I mentioned before, how do we satisfy investing in renewables for example, how do we satisfy also in terms of shareholders?

    So, this all forms part of the treasurer's agenda. Digitalisation and, in summary, data and digitalisation as well as having a very good sense of what's required as part of the necessary transition in that dialogue, with that probably also equity investors. And again, forming the good mindset but also the practices around resilience are to me what forms part of the agenda for treasurer.

    Moderator: Thank you, Abel. That's excellent. So, again, what I'm hearing is on financial expertise is that it's core but it's not necessarily that's it. It's far more than that, and increasingly so, as you mentioned, when you touch on ESG, when you touch on data insights and processes, etc. So, the role is quite varied and, as you say, all-encompassing in many aspects as you interact with other areas within the organisation.

    Abel Martins-Alexandre: That's right, Jeavon, and I would just give an anecdote that I've seen a number of treasuries and I did it when I was a good treasurer, getting more and more of quantitative skills in that team as well as technological skills, right? So, a treasury functions not only about having treasurers or people who are good at corporate finance or pensions but also having quant, coders, and technology experts. That's quite essential as part of the agenda for treasurer.

    Moderator: I would think even with, with us and economics, right, that the range of skills that you can bring in to improve the outcomes is crucial. So, again, we operate obviously as closely as we can with data, quant models as well. So, yes, I'd agree with you. I think bringing those skill sets together to enhance the overall offering is fundamental now for business.

    Abel Martins-Alexandre: It's always good to have an economist as part of the team.

    Moderator: Right, yes, I really appreciate my time with treasurers. Yes, I always find myself learning an awful lot. I'm very grateful for your time today. It's a very complicated area as we just touched on and you've definitely helped my understanding tremendously, so many thanks for your time and I look forward to crossing paths again shortly.

    Abel Martins-Alexandre: Thank you Jeavon. It was a pleasure to be here today, and I am very happy to help.

    Moderator: To our audience, thank you very much for taking the time to watch the episode today. I hope you found the session insightful and useful. And if you have any questions for our speaker today or you would like to just get in touch then please use the mailbox on the next screen. Thank you very much.

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