How should companies integrate new risks?

A globalized world economy, exacerbated by crises

In a globalized economy, the various crises that companies have been experiencing over the past three years are having an increasingly significant impact on their ability to resist and be resilient. The rapid recovery of the world economy, the ongoing pandemic and the military conflict between Russia and Ukraine are all supporting economic uncertainties and highlighting tensions in international trade. Thus, all of these factors (supply chain, raw materials, energy, trade sanctions, etc.) are weighing on international trade and affecting companies' liquidity. Moreover, against the backdrop of rising inflation, climate change has economic and social impacts on companies' future ability to adapt, sometimes modifying their business model and value creation.

Crises have an impact on business resilience and cash flow

Goods shortages, soaring freight costs, longer delivery times, rising labor costs and energy volatility are disrupting the supply chains of French and international companies. This sensitivity to the market dependence of supply chains is strongly associated with just-in-time financial approaches used by companies to limit their working capital requirements and reduce their production costs. In times of crisis, this just-in-time or pull production method, which consists of having materials or products delivered at the exact moment of need for direct use, generates tensions between customers and suppliers, resulting in manufacturing difficulties. This has had an impact on the solvency and liquidity of companies in controlling their cash flow, amplified by the rise in raw material and energy prices, and for some French companies the start of repayment of their State Guaranteed Loan (SGL).

As a reminder, solvency and liquidity are essential elements for the proper functioning of companies; these elements can be analyzed in two ways:

• Static on a calculation of the net cash with the data present in the balance sheet of the company. This approach is strongly linked to two complementary concepts: working capital (WC) and working capital requirements (WCR), one of the parameters of which is the payment period,
• dynamic on an evaluation of the self-financing capacity (CAF). Cash flow is defined as the potential cash flow generated by the company's activity during the year. The observed cash flow is a continuous flow that the company has managed to generate over the course of a year; it does not take into account payment delays with customers and suppliers.

Fragile global supply chains

Thus, the magnitude of the pandemic, the consequences of the Russian-Ukrainian war and the strong rebound of the world economy have today disrupted supply chains. These chains have become extremely long, fragile and complex, with the following consequences

• The saturation of major ports causing major disruptions and even massive delays due to bottlenecks,
• The reduction or stoppage of production on certain food and energy products, coupled with the persistent shortage of electronic chips in the automotive or aviation sectors,
• Movements to relocate and diversify sources of supply initiated by certain large groups to strengthen their resilience, with the choice, depending on the sector, to return to Europe,
• Price increases in the face of persistent production and supply difficulties that could lead to inflationary pressures.

This situation shows the interconnectedness and interdependence of large parts of the world and of states, the problems of sovereignty, the vulnerability of the global supply system and the very high dependence of certain companies on maritime trade. Faced with these crises, companies are adapting their supply chain and production model. To escape this systemic difficulty and to ward off potential shortages, some companies are building up safety stocks or looking for alternative suppliers to secure their growth and, for some, their very survival. However, these adaptations have a cost and impact profitability as well as cash flow.

These strategic orientations are confirmed by the study "Chain Reaction - Holistic Supplier Management is Key to Business Success", commissioned by Ivalua and conducted by Forrester Consulting on companies with at least 1,000 employees, located in North America, Europe and Asia-Pacific:

• 54% of companies surveyed have increased their inventory levels,
• 46% have turned to suppliers closer to home, within or outside national borders.

Another significant risk for companies is the reputational risk in the choice of partners and the values they defend. Companies are increasingly required to be transparent about their business relationships and their possible involvement with politically exposed countries or leaders.

Impact on contractual risks due to the Russian-Ukrainian crisis

Commercial contracts are at the heart of the economic stakes for companies impacted by the Russian-Ukrainian crisis, whether they are customers or suppliers. Thus, French companies trading with these two countries must ensure their compliance with the sanctions set forth by Europe while demonstrating diligence. A commercial relationship with a supplier from these countries may involve a significant legal risk. Under the duty of care, companies must :

• Screen their business partners to identify customers and suppliers with whom transactions are no longer possible while checking their shareholding and beneficial ownership against a list of individuals and companies with whom it is prohibited to do business,
• Study the contracts and the "force majeure" clauses to avoid that the co-contractor claims any compensation,
• Check if the products are not prohibited from export,
• Controlling the payment chain with the disconnection of 7 Russian banks from the Swift financial messaging system since March 12.

The Russian-Ukrainian crisis is increasing the risks for the European economy, and particularly for France, with the emergence of new supply problems whose economic impact will depend on the extent and duration of this tension.

In this situation, companies also have questions about the evolution of energy prices, the shortage of certain components, the difficulty of recruiting and inflation. Will the latter continue, bringing in its wake an economic slowdown, or even yet another crisis? Will central banks be tempted to raise their key interest rates to counter the increase in prices?

The new risks of ecological transition, a threat or an opportunity to be integrated into the future strategy of companies 

All of these realities mean that companies are facing new risks with an uncertain future strongly linked to the duration of the Russian-Ukrainian conflict and the evolution of the impact of Covid-19. Not to mention climate change and its accompanying cohort of increasingly frequent natural disasters. In the face of this climatic tension, the ecological transition is becoming a significant macro-economic event for companies. This transition is driven by :

• Preventive actions by companies committed to Social and Environmental Responsibility - SER - and sustainability criteria, in line with the Sustainable Development Goals - SDGs. Sustainable development was defined in 1987 in the Brundtland report. It is considered sustainable when "development meets the needs of the present without compromising the ability of future generations to meet their own needs",
• The convergence of financial and non-financial aspects in the analysis of a company. One of the objectives of the analysis of these data is to allow for a comparison and an easier evaluation of the CSR performance of companies and their evolution by sector of activity and/or by company size,
• New behaviours of the principals, banks and investors, who include sustainability criteria in their financing, investment or tendering conditions.

These behavioral evolutions are also driven by laws and relayed by taxation or sustainable investment, all attached to future regulations and European directives such as the Corporate Sustainability Reporting Directive (CSRD) or the Taxonomy or Sustainable Finance Discolure Regulation (SFDR). The will of the European legislator is to encourage companies to better integrate CSR into their strategy and business model by relying on a normative and comparable framework.

Thus, to engage in a true ecological transition, it is essential that companies identify, quantify and share their ecological impacts. For some companies, this transition implies abandoning part of the current production mode to move towards new forms of value creation. In fact, the question is no longer whether to make the ecological transition, but how it can be done without threatening the competitiveness of companies in the short and medium term.

Beyond the transition actions themselves, the main challenge today for companies is to enter into transition without jeopardizing their viability, and as far as possible by making their evolution an asset. However, while the search for CSR performance should generate a competitive advantage, it also generates additional costs for the company. Understanding the nature of the relationship and the interactions between CSR performance and financial performance is therefore not so easy for companies.

Sensitivity table of some sectors of activity, completed with the Ellisphere Entrepreneurial Dynamism Index* in 2022

Activity sector	Sensitivity			Entrepreneurial Development Index 2022
	Russian-Ukrainian crisis	Pandemic - Covid-19	Ecological transition
Means of transport	++	++	+++	1,31
Distribution	+	=	++	1,51
Agri-food	++	=	++	1,48
Banks, insurance companies	+	=	+++	2,86
Industrial capital goods	++	=	+	1,15
Construction & Public Works	+	++	+++	1,64
Mining, metals, oil, gas	+++	=	+++	4,11
Pharmacy	=	+++	=	0,89
Tourism	+	+++	+++	1,49

*Ellisphere's Entrepreneurial Dynamism Index (EDI) measures the renewal capacity of a business population in a given geographic area or activity sector (NAF). Over a given period, it establishes the ratio between the number of business start-ups and the number of business closures in metropolitan France. 

 

Conclusion: sectoral and financial indicators are necessary for the management and control of new risks

The resilience of companies in the face of these business shocks, which include the transition to a low-carbon economy, depends on the financial and cash-flow leeway that companies will be able to develop in a context of tightening monetary policy and worsening conditions for bank financing. This is why some sectors raise more concerns and questions than others.

The instability of supply chains resulting from geopolitical, climatic and labor tensions constitutes a significant risk for companies. Thus, having relevant sectoral and financial data around business indicators is essential in managing third parties. Any credit decision requires an understanding of the markets and sectors of activity completed by a financial analysis.

Some sectors of activity are more sensitive to economic, geopolitical or ecological conditions and therefore require a greater amount of information in order to guarantee a quality analysis. Indeed, each sector presents differences in its development. The sector data analyzed in real time must be integrated into the decision-making processes of companies. It provides the knowledge needed to strengthen decisions around third party risk management, asset protection, business continuity and growth in lower risk markets.

Operational risks in companies' value chains are thus directly linked to regulatory, financial, market and reputational risks, to their vulnerability and to hazards. A headache for companies.

In conclusion, we note that international relations, business activity and the ecological transition are closely linked in risk management. Moreover, international conflicts, which are the result of strategic geopolitical choices, are the image of a world in perpetual change. "It is better to take change by the hand before it takes us by the throat", a quote attributed by some to Winston Churchill.

The new business risks
Vulnerability	Points of vigilance
Financial - economic	Inflation, unpredictability of the pandemic and the Russian-Ukrainian crisis, interest rates, lack of cash or equity to support economic recovery, changing business models, supply chain disruptions, trade sanctions...
Geopolitics Supply - Production	Risk of hindrance to international trade, various national or international conflicts, protectionism of certain states, economic, political and social future of international trade, reorganization of global production chains to reduce dependence on supply uncertainties, evolution of the sharing of added value, aging of logistics infrastructures, connected technologies, data transfer...
Energy transition CSR	Meteorological and industrial accidents, climate change, reduction of biodiversity, decrease of natural resources, increase of environmental risks, alternative energy, renovation of buildings, development of soft, shared and collective transport...