Insight on the recent impact of Britain's exit from the EU.
The market volatility experienced during the 2008 financial crisis has driven many firms to review their methods of accounting for counterparty credit risk.
The traditional approach of controlling counterparty credit risk has been to set limits against future exposures and verify potential trades against these limits. Credit Value Adjustment (CVA) offers an opportunity for banks to move beyond the control mindset of limits by dynamically pricing counterparty credit risk directly into new trades.
Many banks already measure CVA in their accounting statements, but the financial crisis has led pioneering banks to invest in systems that more accurately assess CVA, and integrate CVA into pre-deal pricing and structuring. Their expected return on investment is the ability to support future growth by freeing up more capital and minimizing earnings volatility.
But how do you quantify these risks? How, for example, do you measure reputation risk?
In Douglas W. Hubbard’s book, "How to Measure Anything," he defines risks like these and lays out helpful ways to think about quantification. Without that, trying to manage these risks is impractical at best. At worst, it’s a foolish waste of time that does no more than check a box.
Beyond the Box
Arguably, going “outside the box” may not be required in order to employ leading practices in the realm of risk management and regulatory compliance. It is almost certain, however, that managers move beyond the mentality of simply “checking the box.” That is, merely doing anything just to “get it done” will leave the company in an undesirable state. At the very least, managers and employees will be without direction; more than likely, they will go astray and incur even risk without benefit.
Using a proprietary assessment tool, Grayline helps companies evaluate and rank the state of their internal risk measurement and reporting. Contact us today for a complimentary assessment.
With every anticipated interest rate adjustment, we notice an increase of jitters among our clients. If the Fed raises interest rates, will that put a drag on GDP growth or even crush it altogether? They could opt to wait, but such a holding pattern seems unlikely as it could lead to inflation with easy money and “runaway” expansion.
In one article, "What to Expect as the Federal Reserve Decision Nears," author Jeffrey Moore asks the burning question: which way will the Fed lean in order to do the “wrong” thing?
The implications for global business are huge. An increased demand for the greenback will widen the already appreciable gap between the USD and other currencies. As other currencies continue to weaken, this will threaten the earnings of domestic companies generating business abroad.
But before the dust settles, smart companies must decide how to position themselves for rising rates. It’s a matter of when, not if.
How Smart Managers and Board Members Respond to a Potential Interest Rate Hike
“Smart” companies—no matter what size—are doing at least three things to prepare. They always have, to varying degrees. But now they’re doing them with stepped-up urgency and energy:
- Evaluate their company’s debt service and capital structure
- Optimize capital structure around goals and limits
- Take action early
Smart companies also respond to events in the economy by continually reevaluating their position in light of new information. They ask key questions early — and often.
- How is my company servicing its debt today?
- What portion is fixed or floating?
- Will that change if we do nothing? Are there covenants that may take effect under certain conditions? Will those conditions get triggered in a rising rate environment?
- What about my company’s debt/equity mix?
- Have I considered financial instruments that may improve the capital structure?
And smart companies don’t wait until all of the uncertainty is taken out of the equation (that is, after rates rise or after the dollar strengthens or weakens). They know that by then, it’s too late. Instead, they assess their current position, determine the optimal positioning, and act early. Smart companies build risk management into their operations, and the process of assessing, optimizing, and acting is ingrained in the company’s DNA.
The Benefits of a Good Assessment
After assessing its strengths and vulnerabilities, a company must determine the optimal positioning to benefit from (or avoid the downside of) potential events. If the economic context never changed, companies would never need to adjust their balance sheets or capital structure. It is precisely because economic conditions are uncertain–and constantly in flux–that smart companies position themselves to benefit optimally.
Nobody knows exactly what will happen, but every company can be prepared for changes in the economy whether or not they’ve forecast correctly.