Risk Management in Germany

Earlier this year, Schwabe, Ley & Greiner (SLG) conducted a survey among treasurers of German large and medium-sized companies (Mittelstand). Seventy per cent were treasurers from Mittelstand companies with an annual turnover of up to €1bn and the remaining 30 per cent were representatives of large companies with more than €1bn annual turnover.

The survey encompassed 10 core areas related to risk management. When it comes to hedging against potential losses, the respondents were asked whether implications on the balance sheet dominate treasurers’ actions or whether they are guided by purely economic considerations. Economic considerations are clearly the leading rationale for treasurers’ actions with 88 per cent of the respondents agreeing. Only 12 per cent cited implications on the balance sheet as their guiding principle. However, among large corporates this increased to 23 per cent of the respondents.

German legislation has been moving towards a more professional approach, with a reform of the law on accounting principles in late 2004. This means that a further yardstick has been set in dealing with the financial risks of companies and in their communication with third parties. The question posed was whether the new law had led to new trading and documentation procedures. The answers deliver a mixed picture: 44 per cent agree that new requirements regarding documentation have to be met and 31 per cent have introduced new risk managment procedures as a result of the law. But, generally speaking, 53 per cent do not see any new challenges yet. Interestingly, there is no difference between Mittelstand and large companies.

The respondents were confronted with the following scenario: “At the beginning of the year, you are assigned a loss limit with regard to trading operations in the treasury department. After two months, the limit is already fully utilised. What happens now?” The range of replies was impressive: 44 per cent would close all open positions immediately till the end of year in order to avoid any future losses. Twenty-eight per cent would (on a limited and monitored scale) write options in order to earn fees against the losses incurred. Another 22 per cent would ask for permission to extend the loss limit. Seven per cent of all respondents make no indication. Summing up, about half of all companies would try to compensate losses already incurred by trading beyond the limit resulting in an overall increase of risk.

When it comes to budgeting exchange rates, about 50 per cent of the respondents still consider forecasts of banks and independent experts as valuable advice upon which to base their calculations. Advocates of a market based calculation method are still a minority (37 per cent) though this group is growing and a higher number of representatives from large companies share this view (46 per cent).

Is the treasury department under pressure to generate profits? Results from FX and interest income are not considered by 22 per cent of the companies. Thirty-four per cent stated that results should not be below budget, while 18 per cent are expected to beat the budget figures and 26 per cent are expected to maximise returns by trading. The need to beat the figures goes hand in hand with the size of companies (42 per cent among large companies).

The use of key indicators, such as value-at-risk (VaR), is not yet widely spread among treasurers in Germany. Only one-third of all respondents make use of them. However, large companies with a well-established treasury culture are forerunners with 45 per cent of their treasurers employing the VaR and 40 per cent using cash flow-at-risk regularly.

When it comes to qualitative support by banks in terms of risk analysis of the underlying business, a third of the respondents are satisfied, 28 per cent see no need for assistance and 15 per cent did not comment on this matter. Only 10 per cent, however, stated that banks provide a good service and this figure declined to 3 per cent among treasurers of large companies. This figure is even more alarming if one considers the increasing willingness of German companies to reconsider their banking policies.

Finally, the work done by accountants in terms of accounting and reporting hedging transactions shows a clear need for improvement. Although, a well-established corporate treasury culture seems to help assessing the work done by accountants by bridging the lack of mutual understanding.

Another development that is gaining momentum in Germany is a change in the banking policies of enterprises. The relationship between a company and its house banks is under pressure on both sides: banks are measuring their corporate customers far more in terms of profitability criteria than they did in the past; while the banking policies of companies are increasingly determined by objective criteria such as value for money and a bank’s willingness to take risks.

There is currently a downturn in the number of bank relations held by German companies in Germany. Whereas in 2003 companies in Germany with revenues of €125m to €10bn still had an average of 10.7 bank relationships, reduction to 8.6 relationships is expected within two years (mainly to the detriment of German banks). The disappearance of institutional and guarantor’s liabilities has partly led to the demise of competitive advantages of public law institutions, and the market is likely to adjust itself to this situation. Moreover, the generally low earning power of the major banks is repeatedly giving rise to rumours of take-overs and mergers. More than ever before, companies in Germany are therefore facing the need to “back the right horse” in their banking decisions. This is of benefit to better-funded foreign institutions, thus increasing their opportunities in the German market.