Globalization has led to exposures to new and different risks. Large, multinational companies have risk management programs and experts dedicated to managing those threats. Many mid-market companies, however, do not.
These expanded concerns could affect companies’ income and operating statements through volatility in currencies and commodities. And the expectation of interest rate increases only adds to the worry.
“This is the first time there has been volatility in these areas in more than a decade,” says Jim Altman, Middle Market Pennsylvania Regional Executive at Huntington Bank. “Most people haven’t experienced a lot of volatility. Markets have moved in earnest over an extended period, so companies that are focused on the day-to-day can lose track of the bigger picture.”
Smart Business spoke with Altman about areas of increasing risk and forming a strategy to address them.
What are some of the more pressing risks companies face today?
Those who follow the news from the Federal Reserve could get the impression that interest rates will continue to move. Until now, an entire generation of people have traded instruments and run businesses who haven’t had to manage through a rate cycle with rising rates.
In currency, there is a weaker dollar environment. This could help multinational companies that are selling overseas, but it poses a risk for others depending on where their exposures lie.
There is also some concern that the price of commodities could increase, with reports from The World Bank predicting rising costs for energy and agriculture commodities.
How should companies address these threats?
Businesses need to understand not only the risks they face, but quantify how exactly those risks will affect their company. If interest rates go up 3 percent, is that really a problem for the business? If aluminum or copper goes up 25 percent, is that something to worry about? And if the dollar depreciates 10 percent against the euro, will the company feel any effect?
The best way to manage through volatility is to be disciplined. Understand the potential risks and create a plan to deal with them. But know that exposure hedging is a risk-mitigating exercise, not a profit-making activity, in part because forecasting unexpected movements is too difficult to predict.
How well do companies identify threats with enough time to put a plan together to address them?
Some companies are extremely well prepared to face risk. They have veteran managers who are capable of identifying and quantifying the threats facing their business.
Others are less prepared. They tend to operate intuitively or hold on to the notion that markets will settle down soon because in the past five or 10 years, that’s what they’ve done. However, past performance doesn’t guarantee things will be the same in the future.
It’s very difficult to fix a problem once it has manifested. Managing risk means thinking of what could happen in the future and making a plan to brace for a potentially bad scenario.
Banks and risk managers take a long view. They understand the importance of quantifying risk and know that hope is not a strategy. They measure multiple types of risk in a global context. They also know that not every risk needs to be hedged. It’s not possible or recommended to try to hedge against all risks, but where a company faces the chance of significant damage from a threat, there needs to be a plan in place to mitigate or avoid that.
It’s easier to execute against a strategy when a company has a plan that everyone agrees on. Otherwise, there can be a lot of indecisiveness. Discipline works when volatility is on the horizon.
Businesses are coming out of a period of low volatility and potentially a period in which things aren’t going to behave as calmly as before. Companies should identify and quantify risks, and talk to advisers to develop a plan to withstand volatility.
Banks can frame up the problem and work with companies to find solutions. But ultimately it’s up to the company to take action on its own.
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