The CFO: A Catalyst for Change in Uncertain Times
Much has been written in recent years about the potential for broadening the role of CFOs at financial services organizations, including credit unions. Of special concern has been the extension of the CFO’s traditional finance and comptroller role to include greater involvement in sophisticated strategic planning and external communication, and to foster better cooperation with risk management.
The last financial crisis exposed weaknesses in some critical processes within strategic control frameworks and some essential links between finance and other functions. Irrespective of his or her formal responsibilities, the CFO should now play a leadership role in driving the necessary improvements as organizations position themselves for the post-COVID19 world.
The central role of the CFO
Although CFO roles and formal boundaries between finance and other functions vary across financial services organizations, the CFO’s de facto role as guardian of financial reporting and financial statements implies a responsibility for overseeing the financial health of the organization.
As the changing competitive landscape forces financial services organizations to fundamentally rethink their business models, the CFO has an ideal opportunity to strengthen and reshape the way these key processes work together and to kick-start necessary internal changes. While the short-term pressures will be on managing through the crisis, the CFO should take a leadership role in building the foundations for the long-term.
CFO forward-looking agenda
CFOs need to start setting the agenda now. The specific critical areas to address can be captured in
three broad themes:
- Strengthening the approach to strategy and planning
- Reinforcing the operational links between finance, risk and line management
- Improving controls and organization
Strengthening the approach to strategy and planning
The need exists for more rigorous analytical underpinning of strategy, target setting and reviews of businesses’ proposed plans. During the good times, management valued numbers driven by a central growth-dominated scenario. Many were skeptical of risk- adjusted performance measurement and some showed signs of exhibiting a collective amnesia that erased the long-term memory of improbable, but adverse, loss and capital events. Present conditions, however, call for the CFO to seize the day and work with risk management and Treasury to strengthen approaches to projections of the full earnings distribution and to take account of the resultant implications for capital and liquidity requirements.
The CFO should make a stand and focus on a rigorous stress- testing of the organization’s health against specific market scenarios and then develop an action plan-based approach to mitigate business risks. Experience suggests that few financial services organizations have been seriously taking into account scenarios of the type experienced as recently as 2007.
As the ultimate guardian of the financial health of the organization, the CFO should insist on building scenarios that combine unexpected and discontinuous adverse market movements. This preparation should be independent of traditional and theoretical risk measures and frameworks such as economic capital, Basel 2, and Value at Risk (VaR).
Clear communication to a potentially more diverse set of market participants is a third step in strengthening strategy and planning. Not surprisingly, interested audiences have come to expect missed targets and opaque disclosure, and it follows that 2020 investor, analyst and stakeholder meetings will be more challenging than in 2007.
The CFO must now provide:
- A clear articulation of the revised business and financial strategies and how these relate to risk limits and risk appetite
- A specific plan for core but shrinking businesses, including action plans for cost and risk reduction
- A more sophisticated Investor Relations function capable of addressing investor segments spanning public and private investors, traditional and alternative investment firms, and potentially short-term speculators
- Better support for more detailed discussions on risk, capital and liquidity
Reinforcing the operational links between finance, risk and line management
The absence (or breakdown) of strong linkages between finance, risk and line management has been a common symptom of those financial services organizations most affected by the pandemic. Benign markets, fuelled by opportunities for revenue growth, tend to swing the pendulum of influence away from finance and risk functions towards businesses. As the current economic crisis swings the pendulum in the other direction, the CFO must now work to reset expectations and to rebuild this critical operational nexus.
First, the CFO should enforce translation of the Board’s overall risk tolerance (based on outcomes from the scenario planning described above) into divisional revenue, risk and margin targets. This step should, as a minimum, dampen the appetite for liquidity risk, solvency, credit concentrations, and earnings volatility. Furthermore, work towards these targets should be guided by forward-looking revenue, cost and (in close co-ordination with risk management) risk and capital analytics. Each of these elements should be embedded into financial management processes at both the Group and Business Unit levels. Once the targets are in place, the CFO must periodically back-test risk and return results against Board policy-setting decisions, working with the Board to regularly review, in much more depth, the indicators linked to the major risks to the organization – more actively tracking progress on related mitigation strategies.
Second, the CFO should gain an understanding of how share price, capital, liquidity and risk have interacted in the past and how this interaction might evolve going forward. Any new, complex or illiquid products should be routinely scrutinized and evaluated with an adequate tool set.
In this context, the CFO should lead the development and implementation of a new blueprint to guide more effective interplay between the finance, group treasury and risk management functions.
A natural and necessary bi-product of this initiative is more integrated and forward-looking financial and risk information, providing executive management and the Board with more meaningful early warning signals.
Improving controls and organization
Both the structure and control of finance and related functions are essential to making the policies and analytics work in today’s diverse and complex organization. In spite of this essential role, many financial services organizations have fragmented these functions excessively (including an especially worrying siloing of risk types), resulting in a victory for “compliance” over sensible, and appropriately tailored, operational management and control.
The CFO should take the lead in rationalizing and re-prioritizing overall controlling functions, which includes engineering an effective partnership between finance and operational risk management functions. This activity should be supported by an effective top-down risk-based prioritization framework for control expenditures. Early attention should especially be given to dealings with new, illiquid and complex products, and integrated (across risk types) oversight of markets’ business activities. This supervision should be quickly extended to a broader streamlining of the overlaps between finance, compliance, operational risk and audit functions. By tailoring frameworks to the needs of individual businesses, instead of letting them be driven by often competing group methodologies, CFOs can also strengthen the bridges between the financial controllers and the ‘controlled’. For example, regular rotation of staff between front office, risk management and finance will help to increase understanding and make these partnerships significantly more effective.
Finally, given the CFO’s role as guardian of the financial health of the organization, it is absolutely part of his or her role to help shape future incentive structures. As performance management frameworks evolve post-crisis, not only should the CFO ensure an appropriate charge is applied for all risks consumed by the businesses, he or she should also play a very strong counselling role to Human Resources and to the CEO in order to make sure that compensation is clearly aligned with true risk-adjusted profitability and timely creation of value.
The organization CFO sits at the point of intersection of some of the critical management processes whose weaknesses have been exposed by the current credit crisis. To improve linkages between finance, risk management and line management, the CFO must now take the lead in driving a short-term agenda to improve and align critical organization processes operationally as the downturn continues. Over the medium term, the CFO should play an expanded role to more formally bring together the objectives and interactions between strategy, risk and finance, thus helping the organization to emerge in better shape for the post-crisis environment, and to prepare for any future downturns.