BoardMatters Quarterly, April 2012

European debt crisis affects business worldwide

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Questions for the audit committee to consider

  • Has the company evaluated its exposure to the Eurozone crisis and developed contingency plans for its operations and financing? If so, has management shared the contingency plan with the board or audit committee?

  • Does the company have the right resources, including people and technology, in place to manage the uncertainty created by the Eurozone crisis?

  • Has the company adequately communicated the risks it faces in Europe to investors?
Multinational companies with Eurozone exposure do not want to be caught unprepared if the European Union is not able to contain the crisis.

Companies with exposure to the Eurozone are carefully watching the financial and political crisis in the European Union

Many companies are planning for potential financial, operational and reporting challenges in case the debt crisis in Greece resists the recent short-term fixes, or spreads to such other countries as Ireland, Italy, Portugal or Spain.

So far, the International Monetary Fund, the European Central Bank and the European Union have managed to stave off the most severe symptoms of the crisis, but observers note that the underlying problems may take years to resolve.

The European Union shares a common currency but, in contrast to the US, is not a fiscal union with the ability to tax or issue debt.

Accordingly, this crisis could play out very differently from the financial crisis that peaked in the US in the fall of 2008 and remains fresh on the minds of corporate executives and board members.

In 2008, US companies were shocked by how rapidly the mortgage crisis spread through the entire financial system. Companies struggled to keep up with information flow as the situation deteriorated daily. It is hard to predict whether the Eurozone crisis could be more or less severe.

Multinational companies with Eurozone exposure do not want to be caught unprepared if the European Union is not able to contain the crisis. While many experts say the risk of a Eurozone breakup is remote, the possibility of prolonged austerity in certain member countries is more real, and board members are now asking management about contingency plans for addressing these risks.

Understanding and addressing the risks

Many companies have established cross-functional teams with representatives from treasury, accounting, tax, legal, human resources, procurement and sales to develop contingency plans for addressing economic conditions in certain countries, as well as the possibility of an exit of one or more countries from the Eurozone.

These teams are asking whether their companies have the right people with the right skills in place in the Eurozone to manage the risk, and whether they have ready access to the information they would need should the climate worsen.

Companies with significant Eurozone exposure have begun to disclose the types of risk they have identified in their U.S. Securities and Exchange Commission (SEC) reporting. Some risks are universal, such as risks of currency fluctuations on cash management (specifically, a devalued euro), as well as on receivables and payables, and the possibility of inflation. Other disclosures focus on:

  • Eurozone-wide financial risks to the banking system should countries exit the Eurozone and re-establish their original currency
  • The risk of disruption to the normal international payment and settlement systems
  • The systemic risk should sovereign debt defaults inhibit the ability of European banks to lend, similar to what happened in the US in late 2008.

Other risks may be unique to a given company. Some companies have disclosed the risks of:

  • Imposition of governmental controls that would inhibit sales of their products or cause delays in regulatory approvals for products or pricing
  • Governmental actions to restrict trade or to control prices and currency exchange rates
  • Changes in tax laws and tariffs

 Questions for the audit committee to consider

Companies may face difficulties in staffing and managing international operations and changes in country-specific labor regulations. Additionally, companies in certain industries are disclosing risks of business interruption to their supply chains should their suppliers fall victim to financial risks, such as lack of access to capital.

The SEC staff has said that it expects companies to make investors aware of any exposure to European sovereign debt (i.e., government debt of Greece, Ireland, Italy, Portugal and Spain) and non-sovereign debt (i.e., financial institutions and other companies).

Where companies have past-due receivables from product sales or services to government-owned or government-supported customers (such as government-sponsored health care systems), the SEC staff also has requested information about the aging of the receivables by country, the amount of the allowance for uncollectible accounts by country and the basis for the conclusion that the allowance adequately addresses the collectibility of current and past-due receivables for these customers.

The Eurozone crisis continues to present challenges to many countries and the global economy. The crisis is in constant motion, and the implications are reaching far beyond the Eurozone to affect companies and other stakeholders around the world. Boards and audit committees will need to understand these issues, consider the implications for their companies and be prepared to respond.