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By Nick Lord
The year so far has been dominated by news of troubles in the sovereign sphere rather than in the corporate. The latest event came on Monday when Moody's told the US and UK governments that they risk losing their triple-A moniker if they do not take concrete steps to lower their budget deficits. This salvo comes after the well-publicized troubles in Greece and the near-default from Dubai.
CFOs might be forgiven for breathing a sigh of relief as the markets focus on sovereign risks and not on corporate risks. But sovereign shenanigans can and do have a material impact on corporates in a number of interlocking ways. And it is important for CFOs to keep one eye on the macro as they grapple with the micro issues at their own headquarters.
Perhaps the most obvious way in which CFOs need to pay attention to sovereign risk is in the management of their treasury departments. Downgrades and even defaults can have a quick and obvious impact on the value of securities that treasury departments hold as they seek to manage their excess cash. With European and US companies now sitting on almost $1 trillion of excess cash, the ripple effect from poor sovereign performance is felt far and wide.
Secondly, global companies also need to pay close attention to potential sovereign risks such as the imposition of capital controls caused by rapid changes in exchange rates, as these can cause massive disruptions in accounts receivable. As countries' economic situations deteriorate, so the pressure is first felt on the currency. As a result, receivables from both counterparties and internal transfers can get trapped in countries that are seeking to prevent this rapid monetary outflow, as happened in Asia in the late 1990s.
One way to see how seriously companies take this risk is looking at the prevalence of political risk insurance against such events happening. Since this current crisis hit in 2008, insurers have reported a large spike in demand for this business, especially from companies looking to insure their trade receivables.
"For us, the increase in demand for sovereign (and sub-sovereign) non-payment coverage started in late 2008 and it has remained robust ever since - not only for trade receivables but also for medium and long term projects and bonds," David Anderson, Senior Vice President and Regional Manager, Asia-Pacific, at Zurich Surety, Credit, and Political Risk in Singapore, told CFOZone. "Much of that came from a flight to quality as banks retreated from corporate finance, but now they realize that the governments (who have been stressed by bailing out their banks or by the general fall in tax receipts) have their own problems. We have seen pricing drop for many emerging market sovereigns over the second half of 2009, but Greece and Dubai have caused somewhat of a reversal in that trend."
The third clear way that sovereign risk can impact a CFOs life is in finance. Companies operate under the sovereign ceiling of the country they are from. This means that companies can never have a rating higher than their sovereign. In many emerging markets, this is one of the most hated aspects of the global financial system; companies that are flush with cash and have excellent credit can never escape their geographic provenance. Banks in Turkey and conglomerates in the Philippines are two groups that feel particularly aggrieved by this. The impact is clear: with a lower rating their cost of capital goes up and potential counterparty bank lines are lowered.
European bond deals this week showed how companies are being affected by the negative credit perceptions of their sovereigns. Spanish telecom firm Telefonica sold €1.4 billion of five year bonds on Friday at a spread of 93bps over the benchmark rate. This is 22bps higher than when it went to the markets in January. Analysts are calling this increase in spread a 'sovereign credit premium.'
International attention is now focused on Europe's politicians as they seek ways to bail out Greece. And the US and UK governments are under increasing pressure to talk tax cuts (while secretly hoping for inflation) to reduce their deficits. But companies are well aware that risk flows downwards and what can seem a non-related even in a far-off country will soon show up on the balance sheet in many and unpleasant ways.
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