Financial risk management Identify and assess risks

Risk hidden in plain sight SOURCE IMAGE MOST OF US THINK COUNTERPARTY RISK BEGINS AND ENDS WITH BANKS. BUT THIS VIEW OVERLOOKS THE RISK TO CORPORATES’ CASH POSITION FROM CUSTOMERS AND SUPPLIERS, ARGUES MICHAEL STEFANSKY

Counterparty risk occurs fluctuations. But what about could be not to sell anything Bank guarantees where one party in a the customers that owe us to a particular customer or A guarantee or letter of contract is not able to money or the down payments to make it a policy not to credit (LC) is a promise fulfil its obligation to the we extend to suppliers? make advance payments by the bank to assume other. This is a large topic in Do we always think to to suppliers. However, this responsibility for the debt the corporate and banking include these parties in approach could lead to obligation of the customer worlds, but when we talk our discussions on risk a default of the client or or supplier in the event of about counterparty risk management? And how supplier, which, in turn, a default. This arrangement management, the parties should we tackle this area? could harm our company. is tied to certain criteria and that tend to come to mind There are several options There are several other to bilateral agreements first are banks, where we as that can protect a company possibilities in the market between the customer treasurers hold cash and face from the default of a customer – the most appropriate ones or supplier and the bank. currency and interest-rate or a supplier. The first reaction are outlined here. There are a lot of different

44 The Treasurer February 2016 www.treasurers.org/thetreasurer guarantees available, and not received any payment as are taken off balance sheet, Receivable put all of them are useful in this of the due date. There is no but only in case of non- The receivable put allows context, however. (Below you material difference between recourse factoring. the company to purchase the will find a short explanation a payment guarantee right to deliver receivables of advance payment and a SLOC. The latter is Trade insurance to the bank in the event of guarantees and payment primarily used by US banks, Credit insurance is usually a default of a client. After guarantees or standby letters which are not able to use offered to companies wishing a customer defaults and in of credit (SLOC)). bank guarantees and which to protect receivables from case the receivable put has Both can be structured for therefore created the term loss due to protracted default, been triggered, the company short-term coverage or for as ‘standby letter of credit’. insolvency or bankruptcy. delivers its outstanding long as a contract runs. The The usual maturity of such receivables to the bank. After bank usually covers risks that Types of guarantees insurance is a minimum one the bank has validated the they can evaluate. The pricing Guarantees can be direct or year, but as for factoring, this claims, the company is paid of a guarantee is a matter of indirect. A direct guarantee form of protection is often the par value of the receivable credit risk and negotiation is where the bank issues unavailable for high-yield or a predetermined purchase with the bank as well, as it a guarantee directly in or distressed companies. price. This can be set at 100% necessitates a credit line or favour of the company. An pledged cash at the bank. indirect guarantee is where The bank usually covers a correspondent bank is Each company should have a 100% of the amount stated involved and is used in cases counterparty risk policy in place, in the guarantee. The default where the company doubts the trigger is as per contract creditworthiness and financial especially for customers and suppliers specification and as soon as stability of the house bank the counterparty is in breach of the customer or supplier, It may also involve a of the coverage amount or at the company may request due to legal requirements or substantial underwriting a discount. The receivable put funds from the bank. The domestic laws. A corporate process, which is another is a custom-made product to credit rating of the issuing may also use the house bank factor to consider. The benefit address the unique needs of bank is very important and as an advising bank. However, of all this, is that it can be a company. has to be looked at when its only role is to pass the inexpensive for available non- requesting a guarantee. SWIFT message on to the high-yield and non-distressed Conclusion • Advance payment company. This is often done companies. Usually it is not To tackle the problem guarantee – the advance once the company trusts the a full protection due to the correctly, each company payment guarantee client’s bank. deductible on the insurance should have a counterparty serves as a security for policy. Claims made against risk policy in place, especially the reimbursement of an Factoring trade insurance policies can for customers and suppliers, advance payment made by Factoring is a type of debtor be cumbersome, however, and with the definition of the the company in the event finance in which the company may include a waiting period approval process for a request that the supplier fails to sells its receivables to a bank of up to 180 days. for credit lines. Any amount supply the ordered goods or or a third-party provider at above this line should trigger as per the agreed contract. a discount, which covers the Credit default swap a request for protection. In order to make a claim, cost and a risk premium. A credit default swap (CDS) There are many possibilities the company is generally Invoice finance providers offer is a financial swap agreement available, but each company required to declare in factoring on a recourse or non- where the seller of the CDS has to evaluate its needs. To writing that the supplier recourse basis. Factoring on has to compensate the buyer protect large amounts, a CDS did not fulfil its contractual a non-recourse basis is a real in the event of a credit event. or a receivable put is available. obligations properly. protection against a default This is to say that the seller Factoring is feasible to protect • Payment guarantee or of a customer. Non-recourse of the CDS insures the buyer receivables of a company and SLOC – the purpose of the factoring is much more costly against some reference to increase working capital payment guarantee is to than factoring with recourse. loan. The buyer of the CDS at the same time. A bank ensure that the customer The maturity of this type of makes a series of payments guarantee or trade insurance will pay their payment product is usually six months. to the seller and receives a would make sense for single obligation on the agreed The downside of this product pay-off if the loan defaults. customers or suppliers. date. The documents is that it is often unavailable The CDS is a standardised required when drawing for high-yield and distressed product, tradeable on a lot the guarantee are checked companies. It is a lengthy of stocklisted names and against the details given process to establish a factoring therefore only useful if at the initial agreement relationship, as due diligence trading with big names. The most common maturity is the when the guarantee was into the invoices needs to be Michael Stefansky is negotiated. To make a claim, carried out. Factoring is a five-year CDS. A committee a treasury professional the company is required to good instrument for working decides whether or not a working for Swiss default has occurred, and the International Airlines, declare in writing via post or capital improvement, as the and has several years of email that the company has company generally receives recovery in case of a loss is par experience in the banking fulfilled all of its contractual funds earlier than it would minus a specific recovery rate, and corporate worlds obligations, but has not otherwise and the receivables as per the ISDA Agreement.

www.treasurers.org/thetreasurer February 2016 The Treasurer 45