This review1 followed the initial publication of expectations on C&E risks in their November 2020 Guide on C&E risks (the Guide)2 and the self-assessment performed by European banks in 2021 on the ECB’s request. The scope of the thematic review included 186 banks with a total balance sheet size of EUR 25 trillion: 107 significant institutions (SIs) supervised by the ECB and 79 less significant institutions (LSIs) supervised by national competent authorities.

In this article, we provide an overview of the main conclusions of the thematic review and of the main focus areas related to the management of C&E risk for banks that we expect for 2023.

Main results

The thematic review shows that European banks have progressed with the integration of C&E risks into their business strategy, governance, and risk management frameworks. This matters, because the review shows that C&E risks are real. Depending on the time horizon, 70% to 80% of all banks consider C&E risks to be material for their portfolios. About 75% of all banks expect material impacts on their credit risk. To a lesser extent, material impacts are expected on strategic and reputational risks (about 50%), and on market and liquidity risks (about 25%). In the short term, banks are most concerned with transition risks, while the relevance of physical risks is clearly increasing with the time horizon.

The ECB concludes, however, that the management of C&E risks still is on a relatively basic and general level. For example, banks have updated their governance, assigning responsibility for the management of C&E risks to the Management Board. Many have also set up dedicated committees for these risk types and/or assigned responsibility within the organisation in other ways. Further, over 90% of all banks have at least performed a basic risk identification and materiality assessment to understand how their portfolios are exposed to C&E risks. In many cases, this has led to the introduction of Key Performance Indicators (KPIs) and Key Risk Indicators (KRIs), and the (often qualitative) integration of C&E risks into their business strategy and Internal Capital Adequacy Assessment Process (ICAAP).

According to the ECB, the work performed so far is not sufficient though. The ECB observes gaps in the risk identification and materiality assessment at almost all banks. In 60% of the cases, these are deemed major. Of all banks, 10% is yet to start with this process. Improvements are also required with respect to data collection. Only a small selection of banks (about 15%) is systematically collecting data that is sufficiently granular and forward-looking to support processes like risk identification, stress testing and reporting. In most cases, banks rely to a large extent on the use of proxies.

Even if banks have progressed well with the identification of C&E risks, the ECB concludes that this awareness has not been translated effectively into policies and targets by more than half of the banks. The high-level KPIs and KRIs for example, are not cascaded down to business lines or individual portfolios, non-restrictive targets are set, or relevant counterparties are excluded from a policy’s scope. Furthermore, the ECB finds that banks are significantly underestimating the level of skilled resources required for a proper management of C&E risks.

The ECB has set deadlines tailored to each bank that they supervise. As part of the publication of the results of the thematic review, however, they shared the minimum milestones European banks need to adhere to:

• By the end of March 2023, banks need to have a sound and comprehensive materiality assessment in place, including a robust scanning of the business environment.
• By the end of 2023, banks need to manage C&E risks with an institution-wide approach covering business strategy, governance and risk appetite, as well as risk management, including credit, operational, market and liquidity risk management.
• By the end of 2024, banks need to be fully aligned with all supervisory expectations, including having in place a sound integration of C&E risks in their stress testing framework and ICAAP.

Focus areas 2023

Based on the results of the ECB’s thematic review and our conversations with clients, we see five focus areas related to the management of C&E risks for banks in 2023.

1. Comprehensive risk identification and materiality assessment: The ECB is clear about its expectations that banks should complete their risk identification and materiality assessment in the first quarter of 2023. More importantly, they expect this process to be comprehensive. For a start, a bank should assess all its material business lines (or portfolios) and cover all relevant regions and geographies the bank is active in. A step-wise approach can be used, as long as the full scope is covered in the end. Further, the analysis should cover a wide range of physical and transition risks. It is not sufficient to investigate the impact of a limited set of risk factors. Finally, the analysis needs to be performed for different time horizons: the short, medium, and long term.
2. Strong data governance framework: To take the next step in the management of C&E risks, a robust and structured process to collect data is required. For the analyses performed by banks so far, it may have sufficed to extensively use proxies. More is needed, however, to fully meet the expectations described in the ECB’s Guide. Data needs to be collected on a granular level: to be able to properly measure and report on C&E risks, banks need to understand the risks on counterparty, facility, and/or asset level. A first step would be to compile a complete overview of the bank’s data requirements. A bank would need to synthesize all data requirements stemming from processes like risk identification, credit granting, risk modelling, and disclosure to ensure a sufficiently granular (and future-proof) data collection process is designed. Such a process will have to source data from internal systems, but also from a bank’s counterparties and most likely external data vendors. A structured approach exploits potential overlapping data requirements and prevents inconsistencies in definitions.
3. Scenario analysis and quantification: With improved data comes the possibility to perform more sophisticated scenario analysis and to quantify C&E risks. About a quarter of all banks are already employing advanced and/or forward-looking quantification methods; for example to inform the ICAAP, to perform scenario analysis, or to reflect C&E risks into internal ratings-based (PD and LGD) models. Most banks expect that it will take one to three years to truly advance in this area. In 2023, however, banks should already focus on improving their scenario analysis (and stress testing) capabilities, and take the first steps towards integrating C&E risks into their credit risk modelling.
4. Embedding results into policies and risk management frameworks: In 2023, banks will need to “walk the talk”, to paraphrase the ECB. The improved understanding of how physical and transitions risks may impact the risk profile of the bank needs to be translated into actionable policies and become part of the risk management framework. Overall targets need to align with scientific pathways, high-level Risk Appetite Statements on C&E risks need to be cascaded down to the lower business line levels, controls need to be implemented accordingly, product offerings need to be reviewed, and a dialogue with clients needs to be initiated – including clear steps if and how a bank will continue the relationship if the client’s transition is not meeting expectations.
5. Scope extension to other environmental risks: Attention from banks and supervisors alike has mostly focussed on climate risks so far. Other environmental risks, like loss of biodiversity, pollution and water scarcity have received less attention. Now that some progress has been achieved in the area of climate risk, banks should increase efforts for these other risk types. Initiatives like the Partnership for Biodiversity Accounting Financials (PBAF, a sister-initiative of PCAF, which is focussed on financed emissions) and the Taskforce on Nature-related Financial Disclosures (TNFD) can be useful to progress with this.

Since the management of C&E risks is a new field of expertise, many banks are (re)inventing the wheel. Much can be learned from other banks though. To facilitate this, the ECB published, together with the results of the thematic review, an overview of good practices they observed among SIs3. This document can be a useful source of inspiration for banks. De Nederlandsche Bank (DNB, the Dutch central bank) published a similar document, based on their observations among Dutch LSIs4.

Conclusion

Banks have worked hard in 2022 to advance their management of C&E risks. Much work remains, however. With the clear milestones communicated by the ECB, banks have their work cut out for them. And this is not a voluntary effort, as the 30 institutions where the ECB imposed binding qualitative requirements as part of the Supervisory Review and Evaluation Process (SREP) know. For some, supervisory exercises were even reflected in SREP scores, impacting their Pillar 2 capital requirements.

To achieve sufficient progress, we believe that banks should focus on the five areas described in the previous section: risk identification, data collection, scenario analysis and quantification, integration of C&E risks into policies and risk frameworks, and a scope extension to broader environmental risks. By combining our extensive experience with the ‘classical’ risk types with our track record on C&E risks, Zanders is well-positioned to support your organization.

References
1) ECB – Walking the talk – Banks gearing up to manage risks from climate change and environmental degradation – link
2) ECB – Guide on climate-related and environmental risks – Supervisory expectations relating to risk management and disclosure – link
3) ECB – Good practices for climate-related and environmental risk management – Observations from the 2022 thematic review – link
4) DNB – Guide to managing climate and environmental risks – link

1. Digital Treasury
2. Fit for Future Treasury Teams
3. Financial Resilience
4. Increasing Treasury remit

Digital Treasury

Implementing and deploying fit-for-purpose technology in the Treasury function continues to be one of the main themes for Treasurers. The importance of embracing technology, with the aim to become a Digital Treasury function, stems from both internal and external drivers. Due to the strategic position of Treasury within the broader Finance function, different factors (like new regulations, volatility in financial markets, political decision making and economic instability, et cetera) lead to a broader and more complex remit. At the same time, treasurers are expected to implement cost reduction programs while simultaneously facing increasing performance requirements, and the expectation to present accurate and real-time transparency on liquidity, cash flows and exposures. Technology is the key enabler for a future proof value adding Treasury organization including to effectively manage the change in Treasury’s traditional tasks (e.g. requirement for real-time liquidity and exposure data) as well as new tasks (e.g. include ESG Financing, broader working capital responsibility or new B2C payment methods).

A Digital Treasury or Treasury 4.0 as it is often called is defined by certain characteristics:

• Treasury Target Operating Model which is ‘fit for purpose’, this means a formalized governance structure and mandate for the Treasury function in combination with the organizational structure in which ‘virtual’ centralization is achieved by means of technology.
• Fully integrated and automated Treasury operations to reach the highest degree of Straight Through Processing (STP) were possible, which effectively leads to a Manage by Exception (MBE) structure.
• Utilize exponential technology in a standardized way with a clear focus on the additional benefits of this new technology. Deploying exponential technology, like blockchain, AI, robotics, et cetera, should be a means to an end and not a goal in itself for Treasury.
• Enable a ‘Real-time’ Treasury by having real-time data available, process payments on a real-time basis and have access to real-time liquidity.
• Build a resilient Treasury framework of both governance, methodology and technology components to allow Treasury reacting to different scenarios and to anticipate them.
• Shift focus on the full financial supply chain and working capital management by expanding process design and data flow beyond the core Treasury activities.

By embedding Treasury into the financial supply chain regarding processes and data it enables Treasury to work in multiple unforeseen scenarios and make informed decisions based on analytics. When we talk about Treasury data and analytics the “ABCD of Digital Treasury” is paramount, which are:

• Artificial Intelligence (AI) & Application Programming interfaces (APIs)
• Blockchain & distributed ledger technology
• Cloud computing
• Data & advanced data analytics.

As part of the Treasury transformation towards a Digital Treasury, there should be a clear focus on deliverables and output to ensure these are fully aligned with CFO and other business partners expectations. Given the trend of increased focus on performance, it is key to utilize the power of technology which enable Treasury to elevate the quality of deliverables and output. For example, AI can be used to adjust forecasted cash flows based upon the historical patterns behind actuals and forecast variances as well as assisting in decision making in the area of foreign exchange risk or commodity price risk management.

The concept of real-time Treasury has become one of the hottest topics in Treasury over the last few years. The availability of real-time data, payments and liquidity can take away many inefficiencies in Treasury’s day-to-day operations. Thanks to growing adoption of exponential technologies such as APIs and Blockchain, Treasury teams can access external real-time data in a speedy and precise manner. Being able to obtain data from all relevant sources in real-time reduces the manual work, decreases the possibility of errors, and improves the decision-making capabilities of Treasury teams. Rather than having to wait and be constraint by bank cut-off times and end of day processing, Treasury teams can operate more efficiently by achieving actual real-time visibility from faster payments to settlements.

In the pursuit of a better payment system, real-time payments have been evolving and creating a safer, more efficient, and accessible environment. Numerous countries have been creating new payment rails and upgrading their infrastructure to support secure real-time payments. We are seeing blockchain technology challenging the existing payment solutions such as SWIFT to enable real-time payments with extended data and enhanced tracking and tracing at a lower cost.

Real-time payments give rise to the need of real-time liquidity. Banks might offer a solution that enables to leverage liquidity across multiple accounts (without the need to have intraday limits). So, if a bank account requires liquidity to make payments, the bank will look across other bank accounts to check whether other liquidity can be used to cover the payment need.

Enabling the ‘Real-time’ requires Treasury to have a resilient and automated technology landscape. Identifying the requirements and then selecting the technology provider(s is the key component to automated ‘real-time’ functionalities.

Fit for Future Treasury Teams

The most crucial asset of any Treasury organisation is its people. Building a Treasury team that can (a) quickly adapt to new circumstances, (b) understand the added value of the Treasury function for the business, and (c) leverage the use of technology, is a key differentiator when it comes to Treasury. The ability of an organisation to successfully deploy technology stems from aligning three interlinked forces:

• Translating business requirements into functional technology requirements;
• Understanding full capabilities of the new technology;
• Availability and development of functional, technical and change management skills within the team to drive successful implementation of new processes and activities.

Training, retaining the talent and maximizing the business partnering skills is the key to create a fit for future Treasury team. In the recent years, we observe many organisations struggle with building a high-quality talent pipeline and lack of succession planning when it comes to their Treasury functions. This combined with the widening ‘skill gaps’ created by the digitisation of Treasury, puts organisations in a very challenging position. For 2023, we expect companies to focus on developing and managing talent of individuals with digital acumen, ability to interpret data, and ability make forward-looking decisions. This can be done via training and upskilling of current staff, the revision of strategic positions to diminish key-person risk, implementing a broader finance rotation program in which technology plays a central role and lastly entering into strategic partnerships with external expertise and resource partners.

Financial Resilience

Financial Resilience is the ability of an organization to financially withstand and recover from diverse types of unexpected events, for example, external shocks. Coping with financial shocks means, for a Treasury, to have the analytical skills to devise both short-term and long-term strategies to measure and manage the impact of external shocks on the financial side of the organization. Financial resilience requires strategically planning ahead and putting preventive strategies in place, including amongst others detailed analysis of corporate finance strategies, pro-actively creating access to funding sources, and defining alternative risk transfer strategies.

After many years of low interest rates and inflation, treasurers had not to worry too much about interest rate risks (except for the negative yields on their investments). Given the recent interest rate increases by the central banks and the expectation that central banks will further increase interest rates to combat the high inflationary market, interest rate risk is back on the agenda for Treasurers! Treasurers should not only analyse the direct impact of increasing interest rates on the financial expense line, but should also consider how the increasing interest rates, in combination with the increasing commodity prices and volatile FX market impact the full supply chain. There are many (Zombie) companies out there which are on the brink of collapse given the current volatile financial markets in combination with ending government COVID-19 support programs. It is vital for a company to have a clear view on its risk bearing capacity; to which extent is the company able to absorb financial headwinds like increased interest rates, adverse movements in commodity and FX rates and potential defaults of key suppliers and/or customers. Traditional risk management measurement techniques, which consider the linear impact of a change in a single risk factor to a single line item in the financial statements (e.g. financial results), are not suitable in an environment of complexity and uncertainty. Treasurers should upskill their financial risk management practice by challenging the assumptions used in current measurement techniques, like scenario analysis. For example, it was not expected and not in line with economic theory that real interest rates would move below zero, which contradicts the current market conditions of high inflation rates accompanied with disproportionate increases in the nominal interest rate. As guardians of the company’s financial risks, Treasurers should expect the unexpected!

Increasing Treasury remit

Given the critical role of Treasury within an organization, we have already seen (for many years) an increase in the Treasury remit. As strategic partner to the CFO and the business, Treasury’s skills are leveraged for more and more activities. To continue the financial resilience trend, working capital management is a key example of Treasury’s increasing remit in many organizations, which stems from the risk capabilities within Treasury. Treasury is not only involved in securing that the company is resilient for financial market movements but is also acting as a business partner for both procurement and the commercial team to analyse how the full supply chain can be made more resilient. Potential hiccups in the physical supply chain as well as the impact of defaulting suppliers or customers can have a detrimental effect on working capital. Many treasuries have an increased focus on working capital management and evaluate how strategic and critical customers and suppliers can be supported via supply chain finance programs to strengthen the supply chain and thereby the position of the company.

Another key trend which is increasing the remit of Treasury, is the movement towards Environmental, Social and Governance (ESG) proof organizations. Treasurers are the trailblazers in sustainable funding and now need to work with accounting and ESG teams for the necessary reporting. Impact can also be expected in the banking relationship. The European Central Bank (ECB) and European Banking Authority (EBA) are rapidly increasing the pressure on banks to integrate ESG risks into their risk frameworks. For example, the ECB published their expectations with respect to the management of climate-related and environmental risks in 2020 and they are now requiring banks to achieve full compliance by the end of 2024. Among others, banks need to assess to what extent their counterparties are exposed to physical (e.g. floods and droughts) or transition risks (e.g. changes in regulation or consumer sentiment). These factors then need to be integrated in the loan origination process. Apart from the potential impact on the pricing of loans and facilities, corporates can also expect a more data-intensive process. Detailed data on emissions and the geographical location of production facilities may be requested.

Conclusion

To conclude, 2023 is expected to be another exciting year for Treasury professionals! The combination of the expanding Treasury remit, challenging labour market and continuing uncertainties in financial and geopolitical markets give rise to create clear and actionable analysis and advice towards the CFO and other business partners. The transformation towards a Digital Treasury is the path which enables Treasury to deliver in an environment which is increasingly focusing on performance while at the same time becoming more complex. We are optimistic for the future and look forward to collaborating with many of you on this exciting journey! For now, Zanders would like to wish you wonderful holidays with friends and family and a great start of the new year!

As the economy attempts to return to business as usual, their approach around working capital management will require more in terms of planning, forecasting and measures.

The aftermath of a global shock and its impact on supplies can be catastrophic for certain industries. The pandemic exposed the risks of highly concentrated supplier bases. Rapidly changing supply and demand in the semiconductor industry, that caused global shortages and delays in many related supply chains and ongoing lockdowns in China have demonstrated this.

Reviewing supply management strategies

In addition to the ongoing U.S.-China trade war, which reignited under the Trump administration, the war in Ukraine and associated sanctions and embargoes further exposed the vulnerability of global supply chains. Structural shortages in commodity markets, and especially energy prices, are increasing inflationary pressures. These impacts are rapidly building downstream in many supply chains as can be seen in the increasing producer price indices and can be felt by anyone who recently visited a supermarket. Rising prices further increases uncertainty which impacts interest rates and the availability of funds.

It is unlikely that any significant unclogging of global supply chains will happen very soon. Many corporates are reviewing their supply management strategies and practices. The longer a supply chain, the higher the risk of disruption. Western economies have become overly reliant on goods produced and sourced in Asia and with these rising geopolitical tensions, we have already seen countries and multinationals shift their sourcing to mitigate these risks. A great example is Intel’s investments in semiconductor plants in Germany.

Increased requirement

From a working capital perspective, a higher interest rate environment calls for a more efficient working capital performance – corporates would like to offset the higher cost of borrowing by improving their cash flows and reduce their capital requirements. Borrowing funds is becoming more expensive for both short- and long-term loans. Many lines of credit are repriced monthly and therefore higher interest rates hit corporates almost immediately.

Higher interest rates raise businesses’ cost of capital and negatively impact cash flow. Even if a corporate is not highly leveraged, upstream and downstream operational debt, accounts receivables and payables, will have an impact on its liquidity. With higher inflation, increased sales figures, even at constant quantities, means a higher level of balance in trade receivables. Higher purchase prices have a similar effect on the total inventory on the company’s balance sheet. For companies with a positive net working capital, where the sum of accounts receivables and inventory are greater than accounts payables, the extra investment needed in current assets means an increased requirement of working capital financing.

These are some of the main reasons why in these challenging times, focusing on working capital practices, preserving liquidity and cash flow optimization are paramount.

Working Capital Policies

Not in all corporates Treasury is responsible for working capital management. However, to ensure sufficient cash to fulfill all obligations, the impact lies with Treasury.

The working capital management concept pertains to how firms manage their current assets and liabilities to ensure continuous day-to-day operations. An important aspect of Working Capital Management is setting the policy, or set of rules, that best suits a specific corporate or industry.

The working capital policy comprised of two elements: (1) the level of investment in current assets and (2) the means of financing current assets. When selecting the most suitable policy, firms try to obtain an optimal level of working capital dependent on the trade-off between risk and return.

When examining these Working Capital Policies, three general approaches can be distinguished:

1. The conservative policy, where firms aim to maintain high levels of working capital (high investment in working capital), as they rely more on long-term financing compared with short-term financing, decreasing both risk and return.
2. The aggressive working capital approach, where the financing mix of a corporate leans more to the use of short-term capital to finance its investments, which indicates lower structural investment in working capital. Increasing risk and return.
3. The hedging or matching policy, where short-term assets are matched with short-term liabilities and the permanent amount of short-term assets is financed by long-term financing resources. Thus, the investment in working capital may increase or decrease according to the firm’s activity.

Corporates that employ the conservative or hedging approach are least likely to be affected by the recent challenges of higher interest rates as the cost of capital has been locked in for a longer period of time. Companies that have taken a more aggressive stance are among the first to witness the inflationary impact in their overall cost of capital. Although the Working Capital Policies are mainly driven by business strategy and industry complexity, it might be worthwhile for businesses to reconsider these policies now capital structure is becoming a more important factor.

Working capital is often measured by the Cash Conversion Cycle (CCC): Days Sales Outstanding (DSO) + Days Inventory Outstanding (DIO) – Days Payables Outstanding (DPO). It indicates how long each net input currency is tied up in the production and sales process before it gets converted into cash received. It considers the time needed to collect receivables and the time it has to pay its bills without incurring interest or penalties. The cash conversion cycle is optimized (lowered) by increasing DPO and decreasing DSO and DIO.

While profitability is often the key focus point of many companies and managers, working capital and cash conversion are both the heart and the blood of a company. It is an undeniable truth for many Treasurers and CFOs: ‘Cash is king’. Businesses need cash to soldier on, build strategic alliances, propose items that will elevate its competitive stature over time and increase future profitability.

Unique times

Over the course of the last decade, corporates have grown accustomed to low, and even negative, interest rates and high availability of cash in the market and many have taken an aggressive stance in their working capital investment strategies. Especially corporates that operate in the lower margin and highly competitive industries. These recent challenges impact the way a corporate should manage its working capital and to maybe reconsider its working capital policy.

To mitigate the risk of disrupted supply chains, a corporate might first choose to have higher inventory levels that increase their DIO in their cash conversion cycle and their respective capital requirements. Although generally suboptimal, for companies with an aggressive stance, short-term and flexible credit were sensible temporary alternatives to overcome these challenges. In times of rising interest rates however, a corporate’s natural reaction is to decrease its overall capital requirements and reduce the effects of the interest component in their margin metrics.

Now both the challenges of disrupted supply chains and rising interest rates collide, their unique combination presents extra complications to corporates and their Treasurers as typical solutions for one problem are now counterproductive in tackling the second challenge. Furthermore, corporates tied to leverage covenants are faced with a double challenge as these circumstances simultaneously lower the profitability and extend the balance sheet, negatively impacting their leverage metric and consequently increasing interest charges.

What should the treasurer do?

Where in high times working capital management and its financing is ‘just’ a component in a business and corporates can concentrate on the happy flow, crises challenge us to think differently and creatively to overcome our problems. Instead of pushing the issues up and down the supply chain on the short term, a corporate should re-assess its capital structure and financing mix to check its robustness. It is the role of the Treasurer, during times like these, to raise company broad awareness of its impact, gain improved insight in all related processes and to find alternatives.

Businesses are looking for solutions to free up additional funding for their working capital. It is vital that Treasurers look to leverage every tool available to convert sales into cash. The longer that cash is uncollected, the longer it is effectively funding another business rather than the creditors.

Improve on data gather and information

The starting point of successful working capital management is improved insight in cash flows. Treasurers should invest time and resources to optimize cash flow forecasting using the correct data and metrics, which is a challenge on its own. In many instances, existing tools deployed do not take into account deviations from payment terms at a client’s level and the actual flows of cash. Corporates should cross-check credit terms captured in their systems against actual flows to improve their forecasting. Under normal circumstances, reconciliation between the two is already important, but even more so during times of uncertainty that could impact your counterparties and their payment behavior.

While standard practice for a credit insurer, continuously reassessing credit risk of clients and suppliers is something overlooked quite often by corporates. Shipping that order across the globe to your once best customer can become a costly affair when you are unaware of its most recent financial challenges. It is important to have this insight in your supply chain to avoid unpleasant surprises.

Without having a precise and complete insight when cash is coming in and needs to be reinvested, pinpointing your future capital requirement, and where to find these funds, is no simple matter.

Supply Chain Finance solutions to consider

While improving insights, Treasurers should also investigate flexible solutions specifically designed to overcome short-term funding shortages such as factoring and reverse factoring programs.

Factoring programs are initiated from the seller’s perspective within a supply chain and enable the corporate to sell its accounts receivable balances to a financial institution or an investing firm (the factor) for cash advances. This immediately improves the cash conversion cycle by decreasing the DSO component.

Reverse factoring caters to the other side of the supply chain and is focused on financing the downstream flow, initiated from a buyer’s perspective. Invoices to the supplier are paid early or against the originally negotiated credit terms by the factor party. Leveraging the creditworthiness of the buyer, smaller suppliers might benefit from these programs as the discount on the funds received will be lower than factoring programs initiated from their side and extend credit terms could be given. Using reverse factoring solutions increases the effective DPO for the buyer while simultaneously decreasing the DSO from the supplier’s perspective lowering their overall cash conversion cycle.

Whether factoring or reverse factoring is put into practice, the highest mutual benefits can be achieved by initiating the programs by the party with the highest credit rating as their cost of capital is generally lower.

As for everything in this world, it holds in both cases that there is no such thing as a free lunch. Payments are discounted and the costs of finance are similar to short-term loans, but offer increased flexibility on top of existing financial debt. Many of these programs are very user-friendly and most accompanying portals allow for direct integration with many ERP systems to automatically upload invoices to be factored.

Collaborate with key partners in your supply chain

Seek collaboration within your supply chain and adjust planning and mutual initiatives. When considering supply chain finance solutions, do not only investigate initiating your own programs, but reach out to your key suppliers and customers to see whether they are open for collaboration. It is possible that your company can be included in already existing (reverse) factoring programs initiated by your business partners.

Apart from programs involving a third party to finance the supply chain, static and dynamic discounting are other solutions to be investigated. It allows a corporate that is less cash constrained to make direct payments to their supplier at a discounted purchasing price. With static discounting, the discount rate is set in advance, whereas with the dynamic variant, the discount is adjusted to the actual date of payment.

These solutions not only optimize your cash inflow and/or honor the payment terms negotiated, it could also strengthen business relationships in the supply channels through improved cooperation.

Conclusion

In times where both disrupted supply chains and rising interest rates present corporates and their Treasurers with a unique combination of challenges, it is important to gain insight and knowledge about the particular position and needs of your company. Although the solutions to overcome the supply chain disruption by increasing inventory might naturally be counterproductive to lower capital requirements and financing costs, many flexible supply chain finance solutions exist to help a corporate with their cash constraints and to optimize its financing mix.

To gain a better understanding of your company’s working capital position, the potential risks and financing possibilities, Zanders can help you gain insight, explore supply chain finance solutions and make educated decisions.

• Final guidelines for IRRBB and CSRBB (link)ⁱ
• Regulatory Technical Standards (RTS) on the IRRBB supervisory outlier tests (SOT), which updates the SOT for the Economic Value of Equity (EVE) and introduces an SOT for Net Interest Income (NII) (link)ⁱⁱ.
• RTS on the IRRBB standardized approach, which should for example be applied when a competent authority deems the internal model for IRRBB management of a bank not satisfactory (link).

Compared to the draft versions, published in December 2021, the most notable topics and changes are:

• CSRBB: Despite of significant concerns raised by many banks in response to the consultation papers, no significant changes have been made to the draft CSRBB guidelines. Hence, compared to the CSRBB guidelines of 2019, the scope of CSRBB is extended to the whole balance sheet unless it can be argued by the bank that a certain portfolio is not subject to credit spread risk.
• IRRBB: The EBA still expects banks to measure NII at risk including the market value change for positions that are accounted at fair value on the balance sheet.
  The EBA relaxed the constraint on the maximum weighted average repricing date (of 5 years) for retail and non-financial non maturing deposits (NMD) as introduced in the draft guidelines. Retail deposits with economic or fiscal constraints to withdrawal are now exempted from this specific guideline. The guideline on deposits taken from financial institutions is also relaxed. The maximum weighted average repricing date for operational deposits is changed from overnight to 5 years in the final guidelines (following the definition in the LCR regulation). The weighted average repricing date for other deposits taken from financial institutions remains constrained to an overnight repricing.
• NII SOT: In the consultation paper, the EBA requested feedback on different approaches to report the NII SOT. In the final document the EBA made the choice to define the NII SOT as:

• implying that the decline in the 1-year NII must be below 2.5% of the Tier 1 capital.
  Further, the EBA decided that the NII SOT should be calculated based on a narrow definition, where NII is defined as the difference between interest income and interest expense. Market value changes in instruments accounted for at Fair Value, and interest rate sensitive fees and commissions are excluded from the scope of the NII SOT.
• EVE SOT: In the consultation paper, the EBA used the swap curve as an example for the risk-free curve that can be used for discounting. This has now been changed to OIS curve. The EBA indicates, however, that the bank can choose the risk-free yield curve according to their business model, provided that it is deemed appropriate. This leaves room for banks to keep using a non-overnight swap curve.
• IRRBB Standardized approach: The most notable change compared to the consultation paper is the fact that the EBA decided to not include the impact of instruments accounted at fair value in the standardized NII (at risk). Next to this, some minor clarifications have been included.

The IRRBB guidelines are effective as of 30 June 2023 and the CSRBB guidelines are effective as of 31 December 2023. When banks must apply the RTS on SOT will depend on the approval by the European Commission.

ⁱ Earlier, Zanders published an article describing the main changes for the measurement of IRRBB and CSRBB based on the draft publication.
ⁱⁱ Earlier, Zanders published an article describing the main changes for reporting the EVE and NII SOT based on the draft publication.