With the war in Ukraine, spiralling energy costs, global supply chain bottlenecks, 2022 delivered the biggest inflationary shock for more than 40 years.
Central banks had already begun to increase their interest rates – the Bank of England put its rate up from 0.1% to 0.25% in December 2021 as it could already see inflationary pressures gathering. But it then proceeded to increase its rate throughout 2022, including a 0.75 percentage point increase in November 2022, the largest increase since the UK crashed out of the European Exchange Rate Mechanism in September 1992.
In February 2023, the Bank increased its rate to 4%, the highest since October 2008 – a time of falling interest rates and financial crisis. But at the same time, the Bank downgraded its stark warnings of recession – having earlier predicted that the UK economy would enter recession in the fourth quarter of 2022, by February 2023 it was saying that it expected a shorter and shallower recession.
Amid these interest rate headwinds, foreign exchange also saw more volatility in 2022 – in January 2022, the pound was worth up to $1.3712. It then spent most of the year falling, most notably in September when it hit the depths of $1.0697. By February 2023, it had climbed back to $1.23. The euro followed a similar, though not as extreme, pattern against the dollar, dropping from $1.1455 in February 2022 to below parity in August, where it stayed until picking up in November, reaching $1.1013 in February 2023.
Commentators expect such movements to continue during 2023, although there is a growing view that some economies could be reaching peak inflation.
So, the question now is, how will corporates respond in 2023; how will they ensure they are not shaken by this cocktail of volatility?
Many corporates will want to continue their investment and growth path, in spite of choppier waters. Yann Umbricht, partner and head of treasury at PwC, sees many companies continuing to invest in acquisitions and on the technology that underpins growth. “What I see is a lot of companies investing still – even in this world of uncertainty. The easiest option is to stop investing and be on the safe side, on the assumption that business will come back. But I don’t think chief execs have that option any more. They have to know the direction of travel and they need information that’s going to help them make decisions. The ‘stop and go’ strategy is less of an option than it once was,” he says.
Alex Griffiths, managing director, head of EMEA corporate ratings at Fitch Ratings, says that while conditions for 2023 are undoubtedly challenging for many sectors and industries, that won’t necessarily translate into mass downgrades in credit rating terms.
“It’s fair to say that the post-COVID honeymoon is over and the overall message for 2023 is that we see things deteriorating across the board. We rate some of the world’s largest and most flexible businesses and what we expect to see is that – despite all the best planning – there will be some companies that will end up getting things wrong,” he says.
The distinguishing mark of companies that will weather the downturn better, he comments, is forward planning. “A 2023 downturn has been on the cards for some time, so most companies will have been planning for it. Less forward-thinking ones could be planning for it now. The problems are going to come from that minority of companies that just don’t have plans because their situation is so weak.”
Current conditions may test the mettle of some newer organisations – those without treasury functions, perhaps. Less so, for those with experienced treasurers, however. “For me, it’s a return to normal,” says Paul Wilde, treasurer at Shawbrook Bank. “Shawbrook is a domestic bank, so we don’t really have FX exposure, but banks, even medium-sized ones like ours, have very big exposures to interest rates. Like most banks, we match all our interest rates assets and liabilities very carefully to limit our net exposure. Where we do have net exposure, we carry out large derivative hedging.”
As a domestic bank, Shawbrook Bank gets much of its funding from retail deposits, Wilde says, but accesses debt capital markets for securitisation and Tier 1 and Tier 2 debt. “Those markets have been very difficult, and they’ve probably impacted the non-bank lending sector even more severely,” says Wilde. Treasurers in those companies will be depending on the war chests built up over past years, he suggests.
Even so, interest rates are still some way off their long-run average. Many businesses, especially those that are risk averse, will have hedging policies and procedures that are more than a match for the near to medium-term conditions, says Sarah Boyce, director, policy and technical at the Association of Corporate Treasurers. “A lot of treasurers who have needed to, have seized the opportunities of the past few years. They have hedged themselves out, raised as much debt as they’ve needed to. They’ve done as much as they possibly can – because it was never going to last.”
Regardless of market sector or geography and the particular risk profile of the business, lessons in risk management are live at the moment, says Wilde. Speed and efficiency in treasury operations must be a priority, he says, along with effective communication with the rest of the business.
In easier times, there can be pressure from management to relax policies or guidelines for competitive reasons, he says. Pricing structures are a case in point.
Businesses have to look at their pricing structures and take a measured view of their implications in today’s climate. “If you’re giving a fixed price to a customer for a certain period up to delivery, if the price of your goods changes – if they go up and you’ve not priced that in, you suffer a loss. That kind of volatility can really impact businesses,” he says.
As treasurers understand full well, there is a triumvirate of risks that will make life harder for some organisations.
“What you’re looking at is a combination of exposure to inflation, consumer focus, plus high leverage and some exposure to floating rates and refinancing,” says Griffiths. In particular, highly leveraged companies will be under the microscope, as any further hikes in interest rates impact materially cashflow.
“If you look across the rating spectrum – we look at a lot of leveraged companies. These have typically arisen from leveraged buy-outs and often carry a huge amount of debt. If you are talking about five, six, seven-times cashflow leverage and your effective interest rate goes from, say 4% to 10%, that is a material change in the cashflow.
“This is the sub-group we’re really most concerned about – in particular, those entities that have not recovered from the pandemic. Companies in consumer-facing sectors such as restaurants and lodging will face pressures.
“The good news is we think the ratings for those companies already reflect these risks, so we don’t expect blanket downgrades. The rating tells the story quite clearly.”
The ability to access capital markets will also be a carefully watched area in the months ahead. More than ever, treasurers will need to be in a state of preparedness.
The market for investment grade debt has been relatively stable, Griffiths points out, albeit more expensive. High yield has been highly volatile, however. “I suspect things will gradually improve next year,” he says.
“We’ve seen in the last month or so mild improvements in conditions, and when that happens, we often see companies go to market. Demand is definitely there. Market activity was dampened in 2022 because a lot of the companies that would have refinanced last year had already done so in 2021.
“So, you had a combination of rates getting higher and very few companies actually having to access the market because the maturities got pushed out so much when rates were cheap in 2021.
“If you step right back from it, you start to see maturities and they get really quite substantial in 2024. Typically, companies will start thinking about a refinancing about a year before they have to, which means that in 2023 there is going to be a lot more demand for new debt.”
One side of that equation is going to be very different to what it was in 2022. “One of the problems financial markets – bond markets – have had is working out where the peak interest rate is. If you can work out peak inflation, you can start to price things properly. If you simply don’t know, it becomes very hard to take a view,” says Griffiths.
The volatile situation has increased interaction with investors and backers. “We’ve done a lot of work with our debt and our securitisation investors,” says Wilde. “We’ve created an investor relations team to reach out to them regularly. With investor relations, you do the work beforehand,” he says.
With liquidity and access to capital markets more constrained, both investors and issuers will have to move more swiftly to get deals away. The danger is that investors may have to walk away from deals if they lack time to carry out the necessary due diligence, Boyce suggests.
Non-deal roadshows, which were more of a feature prior to the Global Financial Crisis, are increasingly back on the table, she says. “Potential issuers can position themselves and everybody can be lined up and ready to go, so that when the market opens everyone can move very quickly,” she says.
Geopolitical risk and sanctions
With recessions a reality for key economies this year, companies will continue to grapple with uncertainty, scanning the horizon for changes in outlook. Kemi Bolarin, head of treasury for Europe at contract logistics giant GXO, is keeping geopolitical risk firmly in her sights. Where and how the company operates, the reality of complying with international sanctions and the need to consider client businesses as well as their own personnel makes for a delicate and complex monitoring task.
As a logistics company, GXO works with a vast range of customers and partners that also have these risks front of mind. “It has been a turbulent couple for years for global supply chain management where the COVID-19 pandemic and the Russia-Ukraine war delivered disruption to supply chains and exposed global dependence on a ‘single source’. The silver lining here is the emerging theme of near-shoring and moves towards reducing reliance on foreign imported materials and the shortening or near-shoring of supply chains to mitigate risk from future disruptions,” she says.
Recession in Europe is an inevitability, whatever the views on its duration or severity relative to other parts of the world. “It presents itself for us as increased costs. Interest rates are going up. We have corporate debts that we are managing, so that manifests in increased costs that go to the bottom line,” says Bolarin. “We have always run a conservative hedging portfolio, hedging interest rate risk, so interest rates are actually core for us.”
Communication with banks likewise has an increasingly frequent place in Bolarin’s working week. Not only do they offer market intelligence and insight into geopolitical headwinds and their fall-out, but banks are becoming instrumental in speaking to the specifics of the business. They are offering advice about conditions and indicators globally, as well as looking at GXO balance sheets to identify where efficiencies can be gained, such as replacing revolving facilities with supply chain or lease finance. “Our expectation is that our banks will continue to offer us strategic advisory services that are tailored to GXO specifically,” she says.
For all the challenges, Bolarin sees 2023 as a renewed opportunity for the prepared treasurer to shine. “While we talk about geopolitical risks and economic risks, I still see this time as bright and exciting for treasury. It’s a once-in-a-lifetime opportunity and one that anyone who is in a constant state of preparedness will be ready for.”
Liz Loxton is a freelance business writer and former editor of The Treasurer
This article was taken from Issue 1, 2023 of The Treasurer magazine. For more great insights, members can log in to view the full issue. If you're not an ACT member, you can sign up for eAffiliate membership.