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Five Gray Swan Events CFOs Need to Watch Out For

  • By Mark O'Toole
  • Published: 3/30/2017

The strength of a CFO is no longer judged solely on centralized processing prowess. Today’s CFOs must be futurists who can operate in a complex world. Those who sit at the top of commodity-intensive businesses know that a gray area exists between the white swan world of well-planned and meticulously executed corporate strategies, and the unpredictable devastation that comes with a black swan event.

Unforeseen and potentially devastating events can occur at any time and, as anyone who works in a commodity-reliant industry can attest, there is no such thing as a non-volatile year. Somewhere amid the calm and the catastrophe are the gray swans, those disruptive events that progressive CFOs can anticipate occurring in the near future.

Black swans vs. gray swans

Black swans are wildly improbable events that business leaders couldn’t reasonably have foreseen, such as the September 11, 2001 terrorist attacks, the 2008 financial market crash, and the negative impact of the decoupling of the Swiss Franc in 2015. There are other events, however, that, while still unpredictable, are easier to prepare for. Today’s CFOs need to be on the lookout for these highly probable gray swans as risk management becomes an integral part of everyday operations.

Here’s a look at five gray swan events that are likely to happen in 2017.

OPEC cuts could drive an increase in oil prices. Coupled with regional energy deregulations and rising tensions with Iran, the potential effects are unpredictable. Companies exposed to oil price changes, particularly oil-reliant manufacturers and airlines, need to stress test the likelihood of an uptick in oil prices and create effective hedging strategies to mitigate the risk.

Trump could put tariffs on trade with China. The imposition of tariffs could lead to grave geopolitical tensions. Companies should be assessing what their exposure to China is, and how potential trade tariffs might impact their businesses. This is particularly true for foreign companies who ship raw materials to China in order to have them manufactured and then sent back to EMEA/U.S. Tariffs will surely impact their supply chains, and they must be prepared to reevaluate their procedures and come up with alternative plans.

NAFTA may be renegotiated. Trump has suggested a 20 percent tariff on Mexico to pay for his proposed border wall. Since Mexico is one of the largest U.S. trade partners, this would have broad impacts that affect everything from the price of commodities that go into producing finished products made in Mexico, in addition to the tax those finished goods will face when they come back into the U.S., to exports of U.S. goods.

One immediate result of this proposal has been a 15 percent decline of the peso against the U.S. dollar, which puts FX hedging front and center in the short term. Will U.S. consumers be paying more for their Coronas? This question has already impacted revenue for companies like AbInbev.

Currency devaluations could strengthen the U.S. dollar. History has shown that corporates were caught flat-footed after Brexit and the Trump win when it came to hedging FX. This is of particular concern to corporates who have an outsized reliance on revenue in a foreign currency. How are they managing this volatility? Do they have visibility into embedded currency risk in their supply chain in order to effectively hedge?

Tax inversions. In 2016, the Department of the Treasury issued a Sec. 385 regulation package that’s among the most complex and detailed tax rules seen in decades. While tax professionals working with these regulations will be cautious of unexpected traps and nuances, the new regulations can be unmanageable without foresight and proper planning. Dealing with tax inversions, the new rules outline implications that impact both U.S. and foreign companies doing business in the U.S. These rules are unlikely to change under a Trump administration since they protect inversions of U.S. companies going abroad. Treasury and the IRS have indicated that they do not intend to generally deny multinationals the ability to use cash pooling arrangements—a modern treasury function used by many multinationals to streamline groups’ interactions with external lenders and to facilitate intercompany financing.

Geopolitical risk. The recent geopolitical landscape has the potential to unravel globalization. With last year’s Brexit, a Trump win and upcoming elections across Europe, there has been a populist move towards protectionism. This has been roiling corporates with currency shocks that have impacted their quarterly earnings to risks faced around potential trade tariffs, regulation and tax.

Be proactive

Anything can happen in a commodity-producing country. Economic or weather-related downturns are bound to happen and to have repercussions for bottom lines. Forecasting the cost of events fits into a trend of treasury operations moving from “transactional” to “strategic.” As treasury departments start to take a more strategic role within organizations, their remits are expanding beyond just cash management and cash forecasting. They now look at enterprise risk, multi-asset hedging, investments, pensions and more. In the case of commodity-intensive corporations, this necessitates having more visibility of commodities exposure and being able to effectively manage related risks.

CFOs don’t stand alone in spotting risk. It’s a responsibility that is shared between commodities procurement, finance and treasury. Both need full transparency around their total net exposure to prevent working in silos, which makes effective hedging difficult.

CFOs are taking a more active role in enterprise risk management working alongside the finance teams. They’ve shifted from reactive to proactive risk reporting. By looking for gray swans, they can break down the barrier between commodities procurement and treasury, giving companies a competitive edge by managing risk to improve margins and reduce costs.

Mark O’Toole is vice president of commodities and treasury solutions for OpenLink.

Gray and black swan events brought on by escalating geopolitical risk will be discussed in-depth at this year’s AFP Executive Forum, sponsored by Bank of America Merrill Lynch, taking place May 21-23 in New York. Register here.

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