- April 20, 2018
- Posted by: Zina Smith
- Category: CT Blog
Sue Harvey, Partner at Campbell Tickell, discusses implementing ‘golden rules’ to achieve financial resilience.
As the environment in which housing associations operate becomes ever riskier, regulatory expectations of boards have risen accordingly. Having a clear view of an organisation’s financial risk appetite has become an important control in balancing strategic ambitions with continued financial resilience. We find that using ‘golden rules’ can really help inform these discussions. How best can this be done?
We have undertaken more than 300 regulatory In-Depth Assessment (IDA) rehearsal interviews for housing associations. During these we explore how, for example, a board is assured that development aspirations can be delivered without jeopardising financial stability.
Articulating financial risk appetite, by way of clearly defined golden rules or cushions, is a strong first-line response to this question and an effective way to demonstrate how board-level assurance is achieved.
In addition to having robust golden rules, the board must be able to demonstrate their understanding of what these rules mean and their application in the business. Weak finances can see your regulatory viability rating fall. Weak rules or poor board control could call into question your governance rating.
The most common golden rules we have encountered include clear cushions over lenders’ interest and gearing covenants. Minimum cash-holdings and floors on levels of liquidity also feature, as do rules about the amount of security available to be charged to lenders or swap counterparties.
Other possible measures include caps on the proportion of income expected from market-facing activities or the amount of working capital locked into the development programme, the share of market tenures in that programme and cushions over other financial covenants, where applicable.
Through our IDA preparatory work, we have distilled four top tips for effective golden rules:
|1.||Under 10 board-monitored rules. Concentrate on three rules that guard your most sensitive vulnerabilities. Too many rules and only the chief financial officer will understand and remember them.|
|2.||Ensure each rule is precisely defined. Everyone must understand there are red lines never to be crossed, rather than goals to be aspired to, or posts that are moveable under pressure.|
|3.||Monitor the golden rules both forwards and backwards. This means going beyond monthly box-ticking, to considering trends and demonstrating the rules will be met in every cash-flow forecast and iteration of the long-term financial plan.|
|4.||Build two-way feedback loops into your stress-testing. Demonstrate compliance or breaches of your golden rules when presenting the ‘perfect storm’. Use the results to adjust the cushions to support any mitigation strategies.|
Boards sometimes struggle to understand or appropriately monitor their own rules, particularly around liquidity. Liquidity rules are often defined either as a number of months before new borrowing will be needed i.e. “we will always have enough facilities to fully fund all our activities for the next 12 months”, or as assurance that the committed development programme can be fully funded out of available facilities (a simple pass/fail test).
It’s when probing these rules that we most often encounter confusion. What is included in the calculation? Does it include facilities that are available but not secured? Does it include any anticipated sales income (clue – it should not)?
How is development spending defined and forward monitored (contracted vs. committed vs. aspirational)? Is the likely impact on the liquidity rules built into every significant new development decision gateway?
Rules are often seen as restricting opportunities, but carefully constructed rules tell you as much about what you can do, as what you can’t.
The golden rule in building a more resilient, entrepreneurial organisation? Implement some robust golden rules.
To discuss the issues raised in this article, contact: firstname.lastname@example.org