09-18-2013, 09:25 AM
The 'New Normal': Five Years on Since Lehman’s Collapse
Susan Crabtree, Marsh - 17 Sep 2013
The five years since the collapse of Lehman Brothers have seen the liquidity management and traditional funding landscapes shift to an era where interest rates are low, bank funding is rare and treasuries increasingly turn to alternative financing to plug the gap that the traditional banks have left behind. This article will assess the effect that this period has had on the treasury function and how treasurers have had to adapt as a consequence.
This shift to a new funding landscape since 2008 has resulted in the risk appetites of companies and traditional lenders diverging. Treasuries have come up against higher costs of borrowing as well as a reduced availability of traditional lenders, which has resulted in bank funding becoming increasingly difficult to secure. Although this divergence is a major issue in itself, a separate source of concern is the heightened scrutiny directed at the decisions of the individual treasurer by various stakeholders, including shareholders, management, regulators and banks themselves.
With this new lending landscape as a backdrop, corporates held on to cash and reduced their risk appetites as they looked to strengthen their balance sheets and minimise exposure to funding shortfalls left behind by traditional lending sources. In addition, banks reduced their lending, which resulted in bank debt appearing less secure, more expensive and generally less certain than before the financial crisis.
This changing landscape meant that corporates started to look to equity rather than debt when it came to structuring the capital within their businesses. Increasingly, treasuries turned to the capital markets to maintain liquidity and alternative forms of financing - such as shadow, or off-balance sheet, financing - increased in popularity. Since 2008, on the occasions where banks have made financing available to corporates, it has been extended on tighter terms and conditions; requiring more restrictive covenants and more specific representations.
In contrast, capital market financing offers businesses more flexibility and freedom to operate due to a lack of controls over the use to which the funds may be put. Although alternative financing sources may offer treasuries more freedom and less restrictive funding, they are still higher risk than traditional bank lending. This is mainly due to the existing lower level of regulation imposed on alternative financing institutions, meaning that such entities are not required to keep the same level of financial reserves relative to their market exposure as that required of traditional banks.
Regulation and recommendations
Domestic and international regulation of the financial sector is one significant area of change following the financial crisis. Many jurisdictions have reformed their regulatory bodies in order to prevent the recurrence of perceived regulatory failings which took place in the run up to the collapse of Lehman Brothers. In addition to the new and increased levels of regulation already put in place, the UK Financial Stability Board (FSB) has published policy recommendations to strengthen the oversight and regulation of the shadow banking system. This shows an intention by regulators to subject alternative sources of financing to a higher level of regulation, increasing the level of scrutiny over such funding.
The continued increase in regulation also means that company decision makers and their actions are under extra scrutiny from regulators. Several government and regulatory entities, most notably in the UK and the US, have shown an intention to hold senior management personally accountable for their actions. If the UK’s Financial Conduct Authority (FCA) investigates a firm, it is likely to look at the conduct of company management as part of the review. Similarly, in the US the Securities and Exchange Commission (SEC) has announced that it will seek to extract admissions of wrongdoing from individuals as a prerequisite to settling a case against a company.
This change in attitude of the regulators is partly due to public frustration around the lack of accountability following the financial crisis. The public, including company shareholders, want to see that action is being taken by governments; both to hold company management accountable for failings and to prevent a recurrence of the events that led to the financial crisis. As a result, there is a heightened level of scrutiny of company decision makers from all stakeholders, including shareholders, company management, regulators and the general public.
A heightened level of regulation, alongside an increase in the number of enforcement actions and a rise in shareholder and public interest, has resulted in company decision makers facing an increased risk of claims being brought against them as a result of the decisions they take. For example, as well as the risk of individuals being held to account by regulators, where a shareholder does not agree with the approach taken regarding the level or means of financing, the treasurer and/or board of directors of the company could face personal liability for those decisions. The personal cost of such claims or investigations being brought against an individual can be huge. In addition, the company itself can incur great expense when responding to, or defending, claims and investigations.
With the post-Lehman Brothers lending backdrop, the conflict in risk appetites of corporates and lenders and the consequent shift towards the capital markets for financing, treasurers have had to assess the risks involved in equity financing against the possible risk of insufficient liquidity on the balance sheet due to lack of availability, or the expense, of traditional bank lending. Increased levels of regulation coupled with additional interest being shown by various stakeholders, has resulted in the decisions of senior management being subject to more scrutiny from an increasing number of interested parties.
In this landscape of lower risk appetites, use of alternative financing and increase in scrutiny of liquidity management, it is crucial that treasurers and other company decision makers get comfort that there are sufficient company indemnification and/or risk transfer mechanisms available to them. The level, and scope, of relevant insurance should be reviewed in light of this changing risk landscape to ensure that the treasurer and board of directors are appropriately protected from the cost of claims being brought against them for the decisions and acts taken on behalf of the company. Without such protection, their personal assets could be at risk should a claim or investigation be brought against them.
Susan Crabtree, Marsh - 17 Sep 2013
The five years since the collapse of Lehman Brothers have seen the liquidity management and traditional funding landscapes shift to an era where interest rates are low, bank funding is rare and treasuries increasingly turn to alternative financing to plug the gap that the traditional banks have left behind. This article will assess the effect that this period has had on the treasury function and how treasurers have had to adapt as a consequence.
This shift to a new funding landscape since 2008 has resulted in the risk appetites of companies and traditional lenders diverging. Treasuries have come up against higher costs of borrowing as well as a reduced availability of traditional lenders, which has resulted in bank funding becoming increasingly difficult to secure. Although this divergence is a major issue in itself, a separate source of concern is the heightened scrutiny directed at the decisions of the individual treasurer by various stakeholders, including shareholders, management, regulators and banks themselves.
With this new lending landscape as a backdrop, corporates held on to cash and reduced their risk appetites as they looked to strengthen their balance sheets and minimise exposure to funding shortfalls left behind by traditional lending sources. In addition, banks reduced their lending, which resulted in bank debt appearing less secure, more expensive and generally less certain than before the financial crisis.
This changing landscape meant that corporates started to look to equity rather than debt when it came to structuring the capital within their businesses. Increasingly, treasuries turned to the capital markets to maintain liquidity and alternative forms of financing - such as shadow, or off-balance sheet, financing - increased in popularity. Since 2008, on the occasions where banks have made financing available to corporates, it has been extended on tighter terms and conditions; requiring more restrictive covenants and more specific representations.
In contrast, capital market financing offers businesses more flexibility and freedom to operate due to a lack of controls over the use to which the funds may be put. Although alternative financing sources may offer treasuries more freedom and less restrictive funding, they are still higher risk than traditional bank lending. This is mainly due to the existing lower level of regulation imposed on alternative financing institutions, meaning that such entities are not required to keep the same level of financial reserves relative to their market exposure as that required of traditional banks.
Regulation and recommendations
Domestic and international regulation of the financial sector is one significant area of change following the financial crisis. Many jurisdictions have reformed their regulatory bodies in order to prevent the recurrence of perceived regulatory failings which took place in the run up to the collapse of Lehman Brothers. In addition to the new and increased levels of regulation already put in place, the UK Financial Stability Board (FSB) has published policy recommendations to strengthen the oversight and regulation of the shadow banking system. This shows an intention by regulators to subject alternative sources of financing to a higher level of regulation, increasing the level of scrutiny over such funding.
The continued increase in regulation also means that company decision makers and their actions are under extra scrutiny from regulators. Several government and regulatory entities, most notably in the UK and the US, have shown an intention to hold senior management personally accountable for their actions. If the UK’s Financial Conduct Authority (FCA) investigates a firm, it is likely to look at the conduct of company management as part of the review. Similarly, in the US the Securities and Exchange Commission (SEC) has announced that it will seek to extract admissions of wrongdoing from individuals as a prerequisite to settling a case against a company.
This change in attitude of the regulators is partly due to public frustration around the lack of accountability following the financial crisis. The public, including company shareholders, want to see that action is being taken by governments; both to hold company management accountable for failings and to prevent a recurrence of the events that led to the financial crisis. As a result, there is a heightened level of scrutiny of company decision makers from all stakeholders, including shareholders, company management, regulators and the general public.
A heightened level of regulation, alongside an increase in the number of enforcement actions and a rise in shareholder and public interest, has resulted in company decision makers facing an increased risk of claims being brought against them as a result of the decisions they take. For example, as well as the risk of individuals being held to account by regulators, where a shareholder does not agree with the approach taken regarding the level or means of financing, the treasurer and/or board of directors of the company could face personal liability for those decisions. The personal cost of such claims or investigations being brought against an individual can be huge. In addition, the company itself can incur great expense when responding to, or defending, claims and investigations.
With the post-Lehman Brothers lending backdrop, the conflict in risk appetites of corporates and lenders and the consequent shift towards the capital markets for financing, treasurers have had to assess the risks involved in equity financing against the possible risk of insufficient liquidity on the balance sheet due to lack of availability, or the expense, of traditional bank lending. Increased levels of regulation coupled with additional interest being shown by various stakeholders, has resulted in the decisions of senior management being subject to more scrutiny from an increasing number of interested parties.
In this landscape of lower risk appetites, use of alternative financing and increase in scrutiny of liquidity management, it is crucial that treasurers and other company decision makers get comfort that there are sufficient company indemnification and/or risk transfer mechanisms available to them. The level, and scope, of relevant insurance should be reviewed in light of this changing risk landscape to ensure that the treasurer and board of directors are appropriately protected from the cost of claims being brought against them for the decisions and acts taken on behalf of the company. Without such protection, their personal assets could be at risk should a claim or investigation be brought against them.