Risk Management

Safeguarding your reputation

Published: Jan 2013

Seeing your company’s name splashed across the front pages is enough to give any employee that terrible sinking feeling. This is even truer for corporate treasurers as their job is not only about cash management and working capital, but also about integrity and personal character.

In this regard, contrary to popular belief, not all publicity is good publicity. Negative exposure can have a ruinous effect on a company’s market standing, credit ratings, bank relationships and investor relations, as well as the ability to attract and retain talent. “Ultimately, diminished reputational value, or ‘soft’ capital, could impact a company’s long-term competitive advantage,” says Rey Sermonia, who previously held the Treasurer position at Qatargas.

Reputation is an important consideration for many directors. Two-thirds (66%) of directors on the Boards of more than 190 public and privately held companies surveyed by the accounting firm EisnerAmper say reputational risk remains their biggest non-financial concern.

However, protecting your company’s brand can seem a bit like fighting fires on all sides. All other risks contribute to a corporate’s reputation, including market risk, liquidity risk, credit risk, foreign exchange (FX) risk, financial crime and compliance, and operational risk. For example, BP’s operational blunder, which caused the Deepwater Horizon oil spill, resulted in the biggest criminal fine in US history as part of a $4.5 billion settlement. The financial cost is compounded by reputational harm associated with criminal charges and an environmental catastrophe, something which will be remembered for generations.

Paul Stheeman, ex-Director of International Treasury at Petro-Canada turned Treasury Consultant, says: “The reputational damage was huge, partly because the disaster hit BP alone and none of its peers. Shareholders are now more demanding as to what can and should be managed by a corporate.”

“Today there are many ongoing enquiries and high-profile investigations into wrong-doings,” adds Gary Williams, General Manager Treasury, Mitsubishi Corporation International (Europe). “The affected parties are more likely to seek settlement through the legal system and these cases are well publicised.”

Although the most significant contributing factors may differ depending on industry, reputation risk is common across all sectors. Stheeman comes to the crux of the matter when he says the biggest risks facing a corporate’s reputation today are those which reflect a lack of internal controls.

Fraud and financial crime: a question of integrity

Eddie McLaughlin, a Managing Director at Marsh Risk Consulting, believes that key reputation exposures facing corporates are around the fidelity of staff and social and ethical responsibility. This is certainly true for the financial services (FS) industry, which has come under severe scrutiny post-financial crisis, resulting in public trust in the banking industry reaching an all-time low.

The banking industry’s standing has been further impaired by a number of high-profile insider trading and fraud cases, such as the UBS rogue trader Kweku Adoboli, who was jailed in November for racking up losses of over £1.5 billion during three years of secretive, off-the-books trades. Billed as the ‘UK’s biggest fraud’, Adoboli was allowed to move from a back office role to the exchange traded futures desk, a move normally seen as a breach of best practice. His public prosecution exposed UBS’ internal compliance lapses for all to see and may lead to more regulation for the industry as a whole.

While banks have dominated headlines in recent months, well-known corporate brands have also taken reputational hits due to fraud and criminal misconduct. Recently, Hewlett-Packard (HP) revealed it had to write-down $8.8 billion after “serious accounting improprieties” were discovered at Autonomy, the British tech firm it acquired in 2011 for more than $10 billion. HP reported a net loss of $6.9 billion, effectively wiping out its profits for the last quarter. Despite assuring the public that it would attempt to recoup shareholder money through the civil courts, the damage was done and HP shares plunged 13% by mid-morning after the announcement. This example shows how quickly a blow to reputation can affect a corporate’s standing in the market and its bottom line.

Today corporates have to stay abreast of a slew of new domestic and international regulations. The world has come a long way since Sarbanes-Oxley (SOX) in 2002, which was a response to the accounting scandals involving Enron, Peregrine Systems and Worldcom, among others.

Notably, more companies are adopting risk mitigation and compliance measures when it comes to the US Foreign Corrupt Practices Act (FCPA) and the UK Bribery Act, according to a recent survey by Kroll Advisory Solutions. In 2011 only 26% of survey respondents said they had put bribery risk monitoring and reporting systems in place. This year, that figure increased to 52% of respondents. Likewise, where 29% of companies said they trained employees and vendors on anti-bribery compliance in 2011, 55% said they had done so in 2012.

However, more than one in five of survey respondents said that “although they are subject to the UK Bribery Act or US FCPA, they have not made a thorough risk assessment, trained the right people, or amended their due diligence process.” This is a worrying lack of oversight and may lead to hefty fines, as well as headline news.

Fraud and financial crime are clearly areas under the treasurer’s remit. To help mitigate these risks, Mitsubishi’s Williams advises treasury to:

  • Have a well-constructed treasury policy and procedures in place, including payment and dealing limits.
  • Regardless of the size of the team, have some level of segregation between tasks, particularly in the payment and reconciliation processes.
  • Perform regular reconciliation of derivative hedge positions to underlying exposures.
  • Have a regular independent review by the audit or internal control department.

Market, liquidity and credit risk

The spectacular failure of Facebook’s initial public offering (IPO), which led to the company losing more than $50 billion in market value (40%) in 90 days, as well as Zynga and Groupon which dropped more than 75% since going public, called in question their business fundamentals and strategy. These companies quickly went from leading lights to laughing stocks in the marketplace. The exposure has also made many other companies skittish about directly tapping the market for funds.

But funding remains an issue for many corporates. Earlier this year, debt-laden directories group Yell dropped around 18% after warning on outlook and banking covenants, and was forced to rebrand as hibu. Many other retail brands have faced similar credit and cash flow problems, such as Comet, Ocado, Hostess and Premier Foods, to name just a few. Experiencing a liquidity crunch meant that these companies have had to slash jobs, shut shops, pull out of non-core markets and go through debt and cost restructuring programmes in order to preserve investor and market confidence – all of which make headline news.

In order to maintain a level of confidence in the business, treasury needs to develop clear, effective lines of communication to its banks, investors, rating agencies and suppliers, in addition to the company’s internal stakeholders, advises Sermonia.

An Assistant Group Treasurer at a large travel and leisure group believes that being adequately funded is the most important reputation risk from a treasury perspective. “Any indication that you might breach banking covenants in the current climate triggers a press reaction. This is particularly true if you are a consumer brand and employ a large number of people, as the press interest might go further than just the financial pages.

“The ongoing worldwide recession has made trading conditions hard, squeezing revenues, and the step change to the banking world has added to the pressure on cash flow, as the cost of servicing debt increased,” she adds.

The Assistant Treasurer suggests pushing for additional headroom in facilities, and focusing on working capital and cash management to improve cash flow. Growing revenues is quite difficult in this economic environment, so treasurers need to lead the way in encouraging a cash culture within their organisations. “There is also a role for innovative banks to develop new products to help with both the working capital and cash management and also ways of reducing the needs for credit lines, for example by using insurance rather than indemnification for chargeback risk,” she adds.

In a new development, UK high street names – for example Tesco, John Lewis and National Grid – have gone down the route of corporate bonds aimed at retail investors. The expansion is driven by a retreat in UK banks’ lending, which has pushed companies that are not large enough to access institutional public bond markets to look for alternative funding resources. However, already some concerns are being raised that retail investors may not fully understand the potential losses they could be exposed to – which could, in turn, result in a negative backlash for the brands and their banks.

Supply chain stress

The sluggish global economy has put a lot of pressure on the financial strength of suppliers. By rationalising their supply chains during the recession, many companies have become more reliant on fewer suppliers and opened themselves up to severe supply chain risk, not only from supplier distress but also natural disasters and other types of business disruptions.

According to the January 2012 Association for Financial Professionals (AFP) Risk Survey, in collaboration with Oliver Wyman Group’s Global Risk Centre, 57% of organisations that view business and operations risks as a major concern identify supply chain disruptions as having the potential for either a “significant” or “very significant” impact on earnings over the next three years. But it is not just earnings that will take a hit if a company can’t deliver products to its customers – the market reputation will also come under strain.

Peter Robertshaw, Senior Vice President of Communications, Active Risk, explains how one large manufacturer discovered that it was reliant on a major supplier that would halt the company in its tracks if it was to stop manufacturing. To develop a dual source, the company built its own factory and started producing the part itself.

Mustafa Kilic, until recently the Regional Treasurer and Group Insurance Manager, Group Treasury, Indesit, tells a similar story. In 2009, the home appliances manufacturer decided to embark on a risk audit that also took into account potential future risks. It identified a Japanese manufacturer that was the sole supplier of a critical refrigerator part. In order to mitigate future risk, Indesit sourced a second supplier in Latin America. As a result, when the Japanese earthquake and tsunami hit in 2011 and closed down the original supplier, Indesit was able to protect its business reputation with advance planning. This is in stark contrast to some companies which didn’t know that they had exposure until their supply chain had been interrupted.

Kilic believes that business continuity risk is the biggest threat to reputation and promotes the concept of key risk indicators (KRIs). In a similar vein to key performance indicators (KPIs), Kilic explains that KRIs are “triggering items” hidden under the radar that could have a profound effect on the business. These risks are interdependent and could result in a domino effect.

Looking for connections between risks is a developing trend, according to Robertshaw. “Typically in the past the Board would have been presented with a top ten risk list,” he says, “but what that was doing was creating a false sense of security. Now people are trying to go beyond the top ten and examine smaller risks that deserve to be looked at because they are highly connected.”

He goes back to the BP oil spill, which was a result of several things coming together to “create the perfect storm”. “BP is a good example – people are monitoring things at an operational level unconnected to the strategic level, which understands that it can ill afford a conflict with the US government because that will lead to its operating licence being taken away. This is a strategic risk but the operational people wouldn’t have seen it,” he says.

The treasurer’s role

Stheeman believes that treasury is a natural function to have responsibility for enterprise risk management, including reputation risk. “Creating awareness at all levels and ensuring appropriate policies and procedures are in place, as well as having sustainable plans in how to deal with an event leading to reputational damage, are essential,” he says.

Marsh’s McLaughlin is not fully convinced that the treasurer is the best-placed person, which he believes should be a dedicated chief risk officer (CRO). However, the debate continues as to whether having a CRO allows employees to relinquish responsibility for risk. McLaughlin argues that it depends on how it is executed. “The CRO should have a mantra stapled on the wall which says ‘it is not my responsibility to manage risk in this organisation, it is yours’. The CRO is a risk coordinator – they are not responsible for every risk in the organisation,” he says.

The final component is making sure that there is a cross-discipline group for crisis and enterprise risk management to develop action plans for safeguarding the company’s reputation.

All agree that developing an enterprise-wide response plan that can immediately be put into action is a critical component to managing risk. Robertshaw recounts how when HSBC’s ATM network went down in May, the bank immediately responded to complaints on Twitter, by first apologising and then providing progress reports until the systems were up and running again. “Social media commentators then tweeted positively about HSBC’s response. Even if something bad happens, you can enhance your reputation if you respond in the right way,” he says, but warns that social media, because of its ubiquity and speed, has the power to destroy corporate reputation in seconds. Robertshaw believes that executive Boards are lagging behind in understanding the power of social media.

McLaughlin’s advice to corporates is to put in place mechanisms for tracking reputational risks across the enterprise and have a separate reputational risk register to understand the kinds of risk that would undermine the company’s reputation. “Part of that is assessing your company’s reputational capital and emotional quotient with clients, because this will help to classify your sensitivity to brand risk,” he says. The final component is making sure that there is a cross-discipline group for crisis and enterprise risk management to develop action plans for safeguarding the company’s reputation.

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