Insight & Analysis

Managing credit risk in a volatile world

Published: Oct 2019

September was a pretty volatile month for any company reliant on commodities or the tourism industry. Unexpected attacks on two of Saudi Arabia’s oil processing facilities and the collapse of Thomas Cook was a stark warning that the need for effective credit risk management is essential.

Small figurines staring at graphs

In the middle of September, drone strikes on two of Saudi Arabia’s largest oil processing facilities at Abqaiq and Khurais slashed the country’s oil production by half. Representing roughly 5% of global oil production, it caused massive disruption of global financial markets. The day after the attack, Brent crude oil futures surged by 20% and Saudi Arabia’s once strong credit rating was downgraded by Fitch from A+ to A, partly due to geopolitical risks in the region and concerns over the safety of the country’s infrastructure.

The sad demise of travel group Thomas Cook that happened less than two weeks later dealt another devastating blow, not only to its 22,000 employees, but to its many creditors. Some 150,000 disgruntled tourists had to be flown home at taxpayer expense, while businesses waiting on a payment from the collapsed company will also be left out of pocket.

These two events, although not directly linked, proved the need for an effective credit risk strategy - particularly because the oil and gas and tourism markets are well known for being volatile. Both markets are vulnerable to weather, terrorism and political unrest, and these factors have the potential to cause financial chaos to any firms entrenched within their supply chain.

“It’s a situation where the markets are currently very volatile due to so much uncertainty being around,” says Ian Tobin, Head of Portfolio for Risk. “This can have a very dramatic effect in terms of credit risk. The number of trades spread across different industries, commodity and energy products can significantly increase the exposure with individual counterparties.”

Indeed, many business’s calculations revolve around their credit ratings, should they be downgraded then more collateral will be called for by counterparties. One of the key things that every organisation needs to have is an efficient credit risk strategy in place, not to mention enough cash in place, or a bank facility in place to cover that downgrade.

Brady’s credit risk system, Tobin explains, is an intelligent platform that can model and map out uncertainty and chaos. “The faster a business can realise that adverse credit events are happening across the world, the faster it can mitigate that risk,” he says. For example, he says, if one of the main rating agencies issues an outlook that a country or a counterparty’s creditworthiness is deteriorating, then their system will help put in place the required credit mitigation workflow.

“Traders can be told instantly that there is no more trading in oil with company X for example, or all trades will be short term, or it will be buys only,” Tobin says. “If company X wants to do more trading, then it will have to post more collateral before the trade is placed to cover any potential default.”

Andy Hartree, Senior Adviser at energy and strategic advisory practice Gneiss Energy, believes that the corporate treasurer is in no different position from anybody else in trying to anticipate these things. “What I have seen over 20 years of watching treasurers trying to second-guess the market is that far too many don’t follow the first golden rule of managing risk - which is focus on what your own business is doing,” he says.

Hartree continues: “Treasurers must look at their own business and think about what the objectives of the business are. It is only then that they should look at how things in the outside world, and outside their control, threaten the ability of the business to achieve those objectives.”

He also argues that when it comes to devising credit risk management policy, treasurers are in the key position, because they ‘have all the right information to be able to do the analysis at their fingertips’. “They can say to the board ‘this is what the risk profile looks like’ and make a sensible policy proposal about how credit risk should be addressed,” he says.

There is an age old saying that you have to ‘spend money to make money’, and that could be part of the problem when it comes to setting out an effective credit risk strategy.

Tobin explains: “Back in June 2014, when the price of oil from the US was US$108 a barrel, no-one could have predicted that by February 2016 it would have plummeted to just US$26. This massively affected many company’s budgets, so buying a credit risk system wasn’t high up on the agenda, which is ironic really.”

Tobin believes that credit risk solutions as a whole can help set the amount of risk a business is prepared to take with a counterparty, and that is a combination of mark-to-market and settlement risk. However, like the American oil crash, recent events, coupled with the ongoing trade war between the US and China and uncertainties surrounding Brexit, mean that credit risk isn’t going away anytime soon.

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