Financial institutions have faced many external challenges in the past. What did we learn from them that can help us in our current predicament? Peter Deans, Former CRO and Director, The Regtech Association in Australia, addresses the challenges that COVID-19 is bringing to the table and how the pandemic will impact business decisions in the future.
External shocks create a multitude of issues that span the short, medium, and long term for businesses. The issues arising from external shocks can be difficult to assess in real-time and there is nearly always great uncertainty on the future direction of business activity, the economy, government and policy makers’ responses, and the consumer and community reaction. Extreme market volatility can also be a distraction from underlying economic activity and sentiment.
Physical events are often accompanied by significant government financial assistance and economic stimulus. Over time, the economic health of a region returns to something approaching normal. Hurricanes, cyclones, flooding, and bushfires are examples of this.
Other events, however, see long term changes in the shape and nature of economic activity. The Asian tsunami and nuclear incident in Japan in 2010, and severe drought and famine in Africa are examples of significant long-term change following an external shock, arising from physical events. The global financial crisis (GFC) is also an example of an external shock of an economic nature that resulted in significant long-term change. Many banks, financial services firms, real estate-related businesses, and other corporations went out of business in the US and Europe. Industry and market segments were significantly reshaped in some sectors.
Pandemics (or near pandemics) are infrequent occurrences and appear to be varied in their nature and impact – often short term and/or localised. The coronavirus crisis unfolding in early 2020 is taking shape as an external shock for all businesses that is likely to have a significant short and medium-term impact. The longer-term impact from the supply chain disruptions, any economic slowdown, and financial markets dislocation is at present unclear.
There will be three distinct areas of focus and consideration by business owners and managers in such a period of disruption and uncertainty.
Employee safety and business continuity
First and foremost, businesses will be considering the safety of their employees. Larger organisations will have well-developed playbooks for events such as pandemics to ensure that staff are adequately protected. For those businesses with overseas operations, this planning will include evacuation plans. As the coronavirus has now been spreading both within and outside China for some six weeks or so now, these plans will have already been enacted for many.
For an organisation without business continuity plans in place, consideration should be given to how the business(es) can operate essential activities and operations by staff – both remotely and onsite. Consideration needs to be given to having multiple teams across a wide geographic area and locations able to operate all essential activities. In the same way organisations have back up data centres, operations need to have back up ‘essential activities’ centres.
Managing ongoing business and financial impact
There are two distinct categories of issues to be looked at:
- The business impact – customer, product demand and supply chain impact and disruption, for example, and
- The financial impact on a business of both the economic impact and any financial markets’ dislocation.
A detailed assessment of business impact will need to be undertaken for an extended period of lower demand, operations disruption and/or extended supply chain disruption. Businesses with operations in Asia, and those who are heavily reliant on outsourced manufacturing or supply chains in Asia (particularly China) will have already looked to address potential delays and interruptions to normal activities. Again, larger organisations will have well-developed plans for short-term business interruptions such as this.
There may be a need to assess the financial impact on outsourced suppliers and business partners. A business may find a supplier or business partner goes out of business during this period.
More creative solutions can involve reaching out to business partners – and even competitors – to pool resources in extreme scenarios, to assist the effective operation across multiple geographic areas. This could involve, for example, having a competitor in a state, province, or country distribute products or provide services for an extended period. In the airline industry, for example, it is common for carriers to assist others to move passengers of other carriers in periods of disruption.
Concurrently, an assessment of the financial impact also needs to be undertaken and monitored. This can involve detailed financial modelling and scenario analysis to understand the financial impact – from profitability, working capital, cashflow, and liquidity perspectives. In addition, for businesses that have debt facilities with financial covenants, this will also entail understanding the potential for any financial covenant breach(es) and/or inability to meet scheduled loan repayments.
Furthermore, the ability of financiers, investors and/or business partners to meet future financial commitments should also be given consideration. During the global financial crisis, there were many examples of the consequential impact on businesses of a financier, shareholder, investor, or business partner getting into financial difficulty and not being able to meet previously pledged commitments.
For startup and tech sector firms reliant upon ongoing equity raisings from venture capital firms, there will need to be a sharp focus on cash flow management and ongoing dialogue with existing equity investments. For many startup and tech sector firms, the current cash burn will need to be significantly curtailed.
Longer-term financial and economic impact
A different playbook is needed for assessing the longer-term impact and economic fallout from any external shock. The longer-term financial and economic impact is always unclear. Will there be a slowdown or a recession – and for what duration? Will there be financial and economic support for certain business sectors?
It can be difficult in these periods to identify opportunities and, for many businesses, survival is the sole priority. There was the temptation for many businesses to make long-sought-after acquisitions of competitors and attractive, adjacent businesses during and after the GFC. For financially strong organisations, this can be a successful and profitable strategy over the long run. There were, however, many examples during and after the GFC of opportunistic acquisitions that were less than successful and saddled the acquirer with significant debts.
The financial impact for many businesses may result in the sale of some businesses and ceasing to operate in some markets (customer segments, products and/or geographies).
For businesses that have seen first-hand the adverse impact of excessive reliance on a market, this will be a catalyst to reassess strategy and potentially reshape its businesses. Some firms will no doubt be dusting off plans to move into new markets and reduce their reliance on China-driven revenue streams. This episode will be a wakeup call on the need for diversification for many businesses.
In a speech in April 2010, Ben Bernanke (then Chairman of Board of Governors of the Federal Reserve System) stated that “the financial crisis that began in the summer of 2007 was an extraordinarily complex event with multiple causes”. Unfortunately, we will probably look back at this period as an “extraordinarily complex event with a single cause” – a new virus emanating from a previously little heard of province in China.
---This article was originally published on 52 Risks.