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The impact of COVID-19 on risk management decision

By Saloshni Pillay, Head of Global Markets Sales & Structuring, Absa Corporate & Investment Banking 

Africa is in a very precarious position as the global COVID-19 pandemic escalates. The financial markets across the continent have been particularly hard hit due to heightened volatility and deterioration in liquidity conditions across various asset classes.

The disruption to global supply chains and trade has caused sizable knock on effects in terms of how companies are thinking about cash management and liquidity. Companies are already facing a myriad of issues and decisions in terms of the sustainability of their business relevance, human capital and digital platforms. With a looming global recession, companies are in a tailspin around all these factors. Key considerations in the short term are how companies will approach and formulate their risk management decisions. It is going to be critical for companies and financial institutions to work together to navigate through this crisis.

Foreign exchange, interest rates and commodity hedging considerations may take a back seat in this environment as the focus is on short term cash liquidity and funding requirements. However, given the extreme financial market movements that we are seeing in oil prices and emerging market currencies and the adverse impact this can have on industry participants, it is prudent to focus on these factors as well.

The South African Rand and Nigerian Naira have been particularly hard hit. The South African Rand has traded as high as 19.35, its worse level ever and equates to 28% depreciation against the USD since beginning of the year. This is largely due to the COVID-19 pandemic and the sovereign downgrades by Moody’s and Fitch further resulting in a significant outflow from the SA Bond market.

The rapid deterioration in the local currency has added considerable pressure on import sectors in SA as costs have blown out significantly even though we benefit from lower oil prices. The second-round effects of the pandemic on SA exports are still being calculated however it is likely to also have some adverse impact in certain sectors given slowdown in the global economy.

Further north, Fitch downgraded Nigeria’s rating to B citing ‘aggravation of ongoing pressures on Nigeria’s external finances following the recent slump in oil prices and the pandemic shock’. The Naira is at serious risk of further devaluation especially given that the budget was cut by 14% due to lower oil revenue.

The rest of the African continent will also be exposed to weak economic and fiscal conditions, rising costs especially those countries with large foreign currency denominated debt and deteriorating trading environments due to global supply shocks.

It is prudent to understand the financial impact that arises from these conditions sooner rather than later in order to ensure medium to long term sustainability.

Foreign exchange and commodities losses can have a significant impact on a company’s income statement and its ability to sustain day to day activities.

Without any certainty on when the pandemic will end, companies should analyse all risk factors that will adversely affect their business in the coming weeks. It is critical to perform sensitivity analysis on financial, liquidity and capital risks and requirements that will be impacted. Companies must remain vigilant over their hedging portfolios in terms of both the impact of financial market dislocations and reviewing risk management policies and strategies.

This is unchartered territory and operating in it will be quite challenging for many companies. They will need banking relationships that not only understands the local market and regulatory environment, but can also help a client understand these dynamics and how they will affect or impact their business, particularly from a financial risk perspective.

For bankers, this means spending time to have an even deeper understanding of the client’s business and how the impact of the pandemic will affect it so that you can help them to develop and refine guidelines on how they can implement and execute risk management policies. Bankers will also have to recommend how clients can shape their decision-making approach when thinking about managing financial risks especially through this crisis. Equally important in this environment, is the need to come up with tools to help companies implement risk solutions in real time.

These are financial risk nuances that a sound banking partner can assist a client with; for example, by providing risk management solutions that create more flexibility during periods of heightened volatility and uncertainty while ensuring cash flow certainty.  Further, appropriate engagement with Regulators is crucial during this time given the nature of possible solutions, cash flow management and cognizance of financial market conditions.

While every client is different in terms of their needs, decision making approach and risk factors, solutions must be bespoke and targeted in terms of the client’s requirements and the markets they operate in.

Spending more time educating clients on how to manage underlying currency and commodity exposures, how they can source liquidity and minimise related costs and make it more efficient for them in managing their balance sheets and income statement requirements is crucial. This will help clients make informed decisions which invariably mitigate the potential financial risks they may face as they run their businesses.