Greece Sneezes, Europe Catches Cold? Avoiding Contagion in Corporate Liquidity & Risk Management
by Mark Beard, Liquidity and Investments Head, EMEA, and Hugo Parry-Wingfield, Liquidity and Investments Market Manager, EMEA, Citi Global Transaction Services
The Greek government’s inability to repay part of its EUR300bn in May has resulted in a European crisis as the EU and IMF were compelled to construct a bailout package of EUR110bn over three years, the largest financial rescue package in history. The effects are likely to be both long-lasting and to extend far beyond Greece. Not only has Greece been forced to implement harsh austerity measures, seen a cut in credit rating and a sharp decline in investor confidence, but the country’s funding difficulties are proving contagious across other countries with similar funding deficits such as Italy, Spain, Portugal and Ireland. While it may be tempting to believe that companies without significant activities in these countries will be largely immune to the crisis, this is not the case. The degree of exposure to the so-called ‘PIIGS’ countries (Portugal, Ireland, Italy, Greece, Spain) amongst foreign banks, and the impact that the crisis has had on euro volatility, means that all companies need to review their risk, irrespective of whether they have direct activities in these countries.
Sovereign and counterparty risk
The emergence of sovereign risk
The 2008-9 crisis emphasised the importance of counterparty risk, and according to a PricewaterhouseCoopers study published in May 2010, 80% of treasurers are now actively engaged in managing counterparty risk, compared with fewer than 40% before the crisis. However, the current European crisis also illustrates the significance of sovereign risk. This is generally an indirect risk; after all, with some exceptions, most corporations do not have long-term exposures to foreign government debt. However, the downgrading of Greece’s credit rating to ‘junk’ status, an affliction that could also hit other vulnerable countries, will have an impact on the credit rating of counterparty banks domiciled in the relevant country. Furthermore, a number of banks have been reported as having significant exposure to PIIGS economies. While it is difficult for treasurers to determine which banks are most affected, it is important to review the company’s panel of banks to ensure that it is sufficiently diversified.
Money market fund exposure
Another way in which corporates may be exposed to sovereign risk is through their money market funds (MMFs). During the global financial crisis, many treasurers sought investment security by investing in government MMFs, i.e., funds that invested primarily or exclusively in government debt. As the immediate crisis eased, investors started to move away from government MMFs and returned to prime or ‘credit’ MMFs, reflected in a fall of over 25% in the use of government funds over the past year, but there is still over EUR15bn invested in euro-denominated government MMFs, and a number of MMFs will include some government debt. It is therefore important for all investors in MMFs to review the investment portfolio of their funds to ensure that the company is not exposed to any unwanted sovereign risk. While MMFs only invest in short-dated debt and longer-term debt within 90 days of maturity, it should be remembered that the crisis in Greece was triggered by the government’s potential inability to repay its debt in May 2010 which could have affected both long- and short-term debt. Treasurers need to establish a clear policy with the board that outlines the company’s risk/reward approach. For example, while some banks will be offering more competitive returns, this should be balanced with a realistic view of risk to ensure that exposure is managed before, not after, market crises hit the headlines.