Business Leaders Summit 2016 - Outlook for risk, liquidity and capital

 

Benedict Brogan, Group Public Affairs Director, Lloyds Banking Group, reminded the audience how prescient the speakers were last year when they predicted sharper market moves and counselled careful risk planning. He invited Richard Moore, Nick Burge and James Garvey, the respective Heads of Financial Markets, Strategic Liquidity and Capital Markets at Lloyds Bank, to share their views and outlook for the year ahead.

ARE MARKETS FUNCTIONING PROPERLY?

There were even more "black swan" events in 2015 than the speakers had predicted and 2016 looks no less challenging, with boards spending more time discussing extreme events. One of the biggest challenges in the coming months will be how Britain votes in the EU Referendum. The Business Leaders Survey results show more respondents worried about China and the Asia-Pacific slowdown than about Europe and "Brexit". Richard Moore warned against sleepwalking into a decision that, whatever the result, will have profound implications for financial markets.

Richard’s main concern, though, is whether markets are functioning properly. We live in an environment where regulation designed to make banks safer has had the unintended consequence of making markets less safe. Banks can no longer maintain inventory, provide liquidity and assume risks on the same scale as they used to. Our business ecosystem is changing. The world’s largest taxi firm - Uber - doesn’t own any cars; the largest hotelier - Airbnb - doesn’t own any buildings; and the largest retailer - Amazon - doesn’t own any shops.

This is an agile environment to which markets are not adjusting fast enough. Richard warned that the dominant logic that presumes continuous liquidity and cheap capital is flawed. The days of the traditional buyer/seller relationship contesting price are over. In their place, he said, we need a relationship based on partnership and transparency of capital, liquidity and operating costs to make sure markets remain effective.

From right to left:

  • Nick Burge, Managing Director, Head of Strategic Liquidity, Lloyds Bank
  • James Garvey, Managing Director, Head of Capital Markets, Lloyds Bank
  • Richard Moore, Managing Director, Head of Financial Markets, Lloyds Bank
  • Benedict Brogan, Group Public Affairs Director, Lloyds Banking Group

HOW BIG SHOULD YOUR LIQUIDITY BUFFER BE?

Whatever the condition of secondary markets, or primary capital markets to obtain fresh cash, ultimately businesses survive on the liquidity they hold on their own balance sheets – their liquidity buffer. This year’s Business Leaders Survey shows 33% of companies have increased their liquidity buffer and made their balance sheets more resilient. Building these liquidity buffers has been supported by the abundant availability of funding in capital markets. But low to negative interest rates and regulatory change mean holding liquidity is increasingly costly and complex.

“Consider being the “buyer of first resort” of your own debt if credit markets fracture.”

James Garvey, Managing Director, Head of Capital Markets, Lloyds Bank

So how much liquidity should companies hold? With greater levels of global uncertainty, Nick Burge talked about the need to stress test a business for the impact of both business specific and external shocks and the need to create stability through less highly tuned balance sheets.

Partnerships are one way to mitigate some of the uncertainty of the market backdrop. Nick cited the example of how the bank works with clients to look at business risks, liquidity risk/needs and to size buffers. Peer comparisons provide a useful benchmark but ultimately it’s a risk decision as to how much liquidity cover to carry versus the cost of holding it.

In another example of successful partnering, Nick detailed Lloyds Bank's role in explaining to policymakers the unintended consequences for corporates of regulatory reform on financing and liquidity management.

The Capital Markets Union (CMU) is the cornerstone of the European Commission’s focus on economic growth and specifically improving financing for growth; and the audience heard from the UK’s EU Commissioner, Lord Hill, on how it will support business in the future. In a recorded video message, Lord Hill explained how the EC’s number one priority is growth and jobs, and how CMU is a cornerstone in making the capital markets more effective for companies of all sizes. He said he wants every company to have access to a broader range of funding sources going forward.

Video: Outlook for Risk, Liquidity and Capital

BE FINANCIALLY AGILE

The Business Leaders Survey highlighted two key corporate imperatives: cost control and balance sheet restructuring. James Garvey expressed his surprise that, despite all the negative news during the second half of 2015, investment grade credit spreads have hardly moved. In Europe, the key driver for this stability is the European Central Bank’s quantitative easing programme. But while money is cascading into Eurozone banks, James is not convinced it is efficiently flowing into the Eurozone economy and helping drive the European Commission’s jobs and growth agenda. He believes the law of diminishing returns could be gradually reducing the effectiveness of QE and wonders whether Mario Draghi’s "big bazooka" of stimulus measures might be losing their impact.

With bond markets anaemic so far in 2016, James’ worry is that the increasing ineffectiveness of ECB QE could trigger the fracturing of credit markets. Other catalysts could include policy change at the ECB, an accelerated upward movement in US interest rates, a change in the dynamics of European politics as a result of the migration crisis, or even Brexit. Richard Moore spoke of banks’ trading capital being reduced and as a result, James warns that if everyone looks to pull out of the credit markets at the same time then he’s not sure the exit doors will be big enough. This could lead to jagged moves in credit pricing.

How to insulate against continued volatility?

Here are James' recommendations:

  • First, be financially agile. Consider being the “buyer of first resort” of your own debt if credit markets fracture
  • Second, fix margins while they remain low and consider replacing high coupon debt with fixed rate debt at current market prices
  • Finally, look to amend and extend existing lending facilities, possibly issuing new, long-dated bonds to lengthen average debt maturity

The team at Lloyds Bank is ready to help facilitate financial agility and ensure our customers are insulated from the risk that credit markets fracture in 2016.

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