Q&A: Making Better Decisions Around Unlocking the Value of an Organization
September 22, 2021
Whatever the size or type of an organization, capital has always been critical to its sustainable growth. However, as businesses find themselves operating in increasingly complex and risky environments, better decisions around the creative and successful use of capital are becoming more and more important.
Through the use and interpretation of data and analytics, new paths to unlocking the capital within an organization can be discovered and explored, helping leaders to protect and grow their businesses.
We sat down with Bryon Ehrhart, Global Head of Strategic Growth & Development at Aon, to explore a new way companies can make better and timelier decisions about risk management and how their debt capital could become part of a dynamic risk management structure.
Q: What is driving the need for companies to think about new capital management approaches?
Bryon Ehrhart: There are several things going on. While the next phases of the pandemic are not entirely clear, vaccination and expected booster levels continue to raise confidence in economic restoration and growth.
In the early stages of the pandemic, many of our clients faced very uncertain markets for their products and services. This uncertainty led to fears, even among leading companies, that debt capital structures were based on business continuity assumptions that were too optimistic.
As fear grew throughout the markets, the U.S. Federal Reserve and the European Central Bank engaged in unprecedented monetary policies that helped our clients manage capital in ways that would not otherwise have been possible. These actions saved many companies, industries and jobs. Most CEOs, chief financial officers and treasurers do not want to allow their firms to see such pressures again — especially if the next scenario exposes a company’s particular weaknesses.
Also, ratings agencies learned that their post-financial crisis stress tests had missed at least the consequences of the pandemic; accordingly, they are looking to adopt even more conservative capital models in the future.
This is a great opportunity for companies to take on holistic risk management processes — not just across the organization but across capital structure as well.
Q: Where do you see an opportunity?
BE:The economic uncertainty related to the pandemic has pushed interest rates even lower. Even though we are seeing inflationary pressures starting to return, the debate around how long-lasting these pressures will be has allowed long-term interest rates to remain very low — for example, the 10-year U.S. Treasury yield is currently just 1.35 percent.
Investors, particularly pension funds, find these low yields challenging for their business models. As investors think about how to improve yields, we think that some investors may prefer to take additional enterprise risks — in exchange for more yield — from companies with good levels of creditworthiness.
We have all heard the story of how insurers have not kept pace with the growth of our clients; this pace, in fact, has decelerated against the growth of the economy since 1986. The opposite is true in the debt market. In fact, debt capital markets have substantially increased their relevance over the same period.
Think about how often a corporate client has compared the cost of risk transfer to the cost of taking on additional debt to help them recover from uninsured or underinsured events. By leveraging the dynamics associated with the low yield environment, we think we can turn our client’s leverage into an opportunity to integrate holistic risk management advice.
Q: How can debt markets help organizations manage leverage?
BE: A material component of the debt capital markets is the swap market. Armed with insight and expertise in enterprise risk, organizations can use this debt swap market to reduce debt leverage upon the occurrence of predefined events.
Q: Can you share an example?
BE: Imagine our client manufactures semiconductors and is exposed to earthquake and supply chain risks that can rise to catastrophic levels.
By taking a holistic risk management approach, Aon can go to that organization’s debt investors and ask them to consider additional yield through a swap agreement, whereby they take on the additional but remote risks of a catastrophic earthquake or supply chain issue. We think some debt investors might take such risks for additional yield, so long as insurance underwriters helped consider the appropriate price for the incremental enterprise-related risks.
Let’s say we were successful in the swap market, and we were able to help our client reduce debt leverage by 5 percent to 15 percent upon the occurrence of the enterprise risk events in addition to the insurance recoveries we structured in the traditional market. We think clients will be open to this innovative approach.
Q: In what kinds of industries will this approach work best?
BE: The approach could be applied across a variety of industries. It’s particularly relevant for companies operating in areas at high risk of natural catastrophes, such as technology in the previous example. We think any client that has debt-to-total-capital ratios in excess of 30 percent should consider the strategy, regardless of industry.
Q: What are potential barriers for leaders to pursue this type of strategy?
BE: New approaches to risk management bring challenges — but, for many leading companies, the insurance markets have lost relevance. This strategy overcomes some of the shortcomings of the insurance industry and charts a course for growth. Aon Securities will help client teams consider these opportunities and is necessary to help our teams comply with applicable derivatives and securities regulations. The good news is that most of our clients are already familiar with transacting in the derivatives market.