Managing Credit risk in Crisis times!

The purpose of this month’s article is to provide Credit & Order to Cash (O2C) professionals with a fresh look at Credit risk management on the backdrop of change & global uncertainty.

by Evelyne Legaux on 14-04-2022

 

The global Landscape – What it means for O2C & Credit professionals

A few months ago, it was already clear that, although political leaders & public actors around the planet were sharing the goal of overcoming the pandemic crisis, the world had nonetheless failed to become more peaceful & stable.

Today, beyond its catastrophic humanitarian dimension, the war in Ukraine is bringing no less than an end to the international order that had prevailed since the end of the Cold War, and is threatening the world with the dark prospect of a wider military conflict, energy supply disruptions, more famine in those geographies highly dependent on Ukrainian grains with further social unrest as a result, etc…

In such a fluid context, it is essential for businesses to understand the impact of a rapidly evolving trading landscape on their business operations.

O2C & Credit leaders in particular must remain on top of interlinked political risk drivers, new global trade rules & emerging commercial risk factors, as well as the impact of same on their Credit risk management strategy.

More than ever, Credit teams must play a pivotal role within the business organization & bring together all customer-facing stakeholders to craft a Credit risk mitigation strategy that best protects international Receivables.

 

Credit risk in crisis times - Key Elements to a Strategic approach

Master the new dimensions of Credit risk

With climate change, supply chain disruptions & ever-changing geopolitical sanctions, post-pandemic global trade opportunities come with a cohort of new risks & hurdles. What this means is new dimensions or ramifications of Credit risk are emerging, that elevate topics such as resilience & sustainability to top priority level.

In the present context, what you don’t want is your business’ own Credit rating to be adversely impacted by your organization’s lack of awareness, visibility or due diligence when it comes to 3^rd party Credit risk assessment.

For instance, do you know that businesses increasingly rate suppliers against a set of ESG criteria & accept to work with A- or B-rated vendors only?

It is therefore more important than ever to thoroughly monitor how the risk profile of your customer base keeps changing. This drives the need for O2C professionals to incorporate a whole set of new risk factors into their Credit risk assessment methodology.

More specifically, no matter where your key customers are located, your Credit scoring model should evolve to become truly holistic & include the following non-exhaustive list of items, beyond purely financial data points:

• Industry / sector’s vulnerability to macro-economic trends (soaring energy & commodity prices, rise in interest rates, downwards revisited GDP projections, etc…),
• Exposure to supply chain disruptions,
• Exposure to trade with Russia, Belarus or Ukraine,
• Exposure to geopolitical sanctions & counter-sanctions,
• ESG-type criteria or Net Zero goals,
• Digitization & process Automation strategy,
• Protections against cyber risk & fraud.

 

Implement Customer portfolio Segmentation

Now is the time to also consider implementing a strategic process of customer Portfolio Segmentation for analytical review, risk category assessment & action. Segmentation can be by geography, industry, account size, business stream or whatever else is meaningful to your business.

The purpose of such exercise is to obtain a “big picture” view of your customer base risk profile. The insights & hidden value that such analysis unlocks is highly valuable to any business of a substantial size.

Segmentation also helps drive the establishment of analytical standards & consistency when it comes to Credit decision-making right across the entire customer portfolio.

Furthermore, as a business enabler, portfolio analytics is key for Credit professionals to position themselves in a pivotal role, helping to drive revenue & profitability therefore create value for their respective business.

 

Promote the Understanding of Political risk

With the unfolding & largely unpredictable Ukraine crisis and the ongoing relationship deterioration between China & Western countries, there has never been a better time to enhance your understanding of Political risk and incorporate it into your wider risk management strategy & governance.

In actual facts, political risks in 2022 & beyond are many:

. military conflict & human rights violations in Ukraine driving a flurry of sanctions & counter-sanctions along with a threat to energy supply security. If you trade with Ukraine, you run the risks of destruction or forced abandonment. If you trade with Russia or Belarus, your biggest risks are non-transfer & reputational damage/opprobrium.

. geostrategic competition between China & the West is likely to have significant financial consequences for businesses, with a growing risk for private companies of being caught in international diplomatic disputes by way of state-driven cyberattacks, use of trade policy to retaliate or political sanctions,

. economic nationalism expected to gain momentum as companies rethink their supply chains with a view to deglobalizing, encouraging domestic production as an alternative & dismantling prior investments in China in particular,

. US democracy in crisis that creates a potential for erratic policy-making, both domestically & internationally,

. turmoil in Asia over the many incidents in the South China Sea, highly sensitive future of Taiwan & tense China-India relationship,

. post-pandemic ongoing risk of sovereign default & deterioration of political freedom in parts of the emerging world (mainly LATAM & MEA regions),

. political instability in several Latin American countries,

. political impact of climate change with a disproportionate hard hit on low income countries.

 

How to best manage Political Risk?

Business owners or leaders should first assess how their company’s activities are being impacted by potential political risk losses, then develop a multi-dimensional approach to best prepare for it & mitigate that risk:

• Many functions such as Business Strategy, Sales, Supply Chain, R&D, Finance, Treasury or HR can typically be affected in different ways. It is therefore essential for companies to determine where the management responsibility for political risk resides at senior leadership level, and ensure that the individual or function in charge can work cross-functionally to coordinate strategies across all stakeholders.
• Once clear responsibilities have been established, companies should carry out an impact assessment of how exposed to political risk each functional area is or might be in the future, and monitor that risk on an ongoing basis.
• The use of scenarios-based analysis for such assessment is highly recommended in uncertain times, along with validating the perception of political risk with external expert sources.
• Companies should also consider factoring political risk into their Enterprise Risk Management (ERM) systems & processes.
• They should also consider purchasing Insurance as another critical & increasingly popular tool to mitigate exposure to political risk (forced abandonment, expropriation, confiscation, currency inconvertibility & non-transfer or political violence). Being highly dependent on a robust re-insurance market, insurers so far continue to underwrite political risk in most countries, albeit at varying price points that reflect actual risk levels. With regards to Ukraine however, while obtaining insurance coverage was difficult since the invasion of Crimea, it has now become near impossible. Companies should therefore work with their brokers & underwriters to ensure that the ever-changing factors of political risk are covered under the terms & conditions (T&Cs) of their insurance policies.
• Finally, with regards to governance, companies should develop an action plan to ensure awareness & understanding of Political risk within their organization, by way of enhanced topical communications & cross-functional collaboration.

Companies that integrate Political risk into their own culture will always be better positioned to mitigate its impact & improve their resilience in the face of global uncertainty.

 

To conclude on a positive note, beyond the challenges crisis times always provide fantastic opportunities for O2C & Credit teams to shine the value they add to the business.

So, do make the most of it!

 

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