July 2023 Articles - Suits the C-Suite | SGV & Co. | EY

31 July 2023

Aris C. Malantic

Effects of climate-related risks on financial statements

In our last article, “IFRS S1 and IFRS S2: Game changers in global sustainability reporting,” the author discussed the first two global sustainability reporting standards published by the International Sustainability Standards Board: IFRS S1 General Requirements for Disclosure of Sustainability-related Financial Information and IFRS S2 Climate-related Disclosures. These standards can be game changers by helping companies identify material sustainability risks and opportunities that will help investors, lenders, and creditors assess the entity’s resilience against changes and uncertainties driven by sustainability-related issues. In response to these new disclosure standards, the International Accounting Standards Board (IASB) republished in July 2023 a document on the effects of climate-related matters on financial statements.Due to the ubiquitous effects of climate change, there is an increased focus on the measurement and disclosure of climate-related matters in an entity’s financial statements. In effect, investors and stakeholders are keen to understand the potential impact of climate change on an entity’s business models, cash flows, financial position, and financial performance.While International Financial Reporting Standards (IFRS) do not explicitly touch on climate-related matters, businesses must consider the latter in preparing their financial statements when the effects of those matters are material. The determination of the effects of climate change on an entity’s financial statements may require significant effort and judgment.At a minimum, entities are required to follow the specific disclosure requirements in each IFRS standard. Entities may need to provide additional disclosures in their financial statements to meet the standards’ disclosure objectives. Hence, in determining the extent of disclosure, entities are required to carefully evaluate what information is required for users to be able to assess the effects of climate change on their financial position, financial performance, and cash flows.Key points for entities to consider are summarized below:Going concern, sources of estimation uncertainty, and significant judgmentsAs a major source of estimation uncertainty, climate risk could add complexity to the application of IFRS. Entities have to consider uncertainties associated with future climate-related developments when assessing an entity’s ability to continue as a going concern. They should therefore ensure they make the relevant disclosure of assumptions and estimates. Those disclosures must be entity-specific and avoid using boilerplate-type or generic language. Entity-specific disclosures include quantifiable information about assumptions, if relevant, and explanations of deviations from known market expectations regarding the same assumptions.If relevant, quantified sensitivity disclosures should be made to illustrate the uncertainty embedded in the estimates relied on by entities. It is also important that entities stay consistent in both the disclosures about climate-related matters outside the financial statements (e.g., in separate sustainability reports or management commentaries) and how they incorporate climate risk in the financial information (e.g., in measurements and disclosures in the financial statements). Long-term climate risk impacts should also be considered when assessing the uncertainty associated with an entity’s ability to continue as a going concern.InventoriesClimate-related matters may cause inventories to become obsolete, selling prices to decline, or costs-to-complete to increase. This may result in inventories needing to be written down to their net realizable values.Income taxesAn entity’s estimate of future taxable profits may be impacted by climate-related matters, resulting in the entity being unable to recognize deferred tax assets. The entity may also be required to derecognize deferred tax assets that were previously recognized. Moreover, an entity may find that climate-related matters affect its future taxable profits potentially resulting in the entity not being able to recognize deferred tax assets for any deductible temporary differences or unused tax losses.Property, plant and equipment, and intangible assetsTo adapt business activities, climate-related matters may lead to a change in expenditures. An entity will need to determine whether these expenditures satisfy the definition of an asset and can therefore be recognized as either property, plant and equipment or as an intangible asset. Both IAS 16 Property, Plant and Equipment and IAS 38 Intangible Assets require entities to review the estimated residual values and expected useful lives of assets at least annually. For example, climate-related matters may impact both of these estimates due to legal restrictions, obsolescence, or asset inaccessibility. Additionally, estimated residual values, expected useful lives, and changes thereto will also require disclosure.Asset impairmentSignificant judgment may be required in determining the extent to which certain assets, processes, or activities will be impacted by climate-related business requirements and how climate-related risks and opportunities will affect an entity’s forward-looking information, such as cash flow projections in the prognosis period. Entities must consider what information users rely on in assessing the entity’s exposure to climate-related risks.Provisions/contingent liabilities and assets/leviesThe recognition and measurement of provisions, as well as the need for disclosure of contingent liabilities, can be significantly impacted by climate-related matters. However, under IAS 37 Provisions, Contingent Liabilities and Contingent Assets, only the obligations arising from past events that exist independently of an entity’s future actions can be recognized as a provision. Due to the significant uncertainties involved in assessing the extent and impact of climate change, entities should ensure that sufficient disclosures are provided to allow users of financial statements to understand said uncertainties. Sufficient disclosures are also necessary to allow users to understand how climate transition has been taken into account in the measurement of a provision or disclosure of a contingent liability, and the assumptions and judgments made by management in recognizing and measuring provisions.Financial instrumentsClimate-related matters such as environmental calamities or regulatory change may affect a lender’s exposure to credit losses, affecting a borrower’s ability to meet its debt obligations to the lender. This makes climate-related matters potentially relevant in the calculation of expected credit losses if, for example, they impact the range of potential future economic scenarios or the assessment of significant increases in credit risk.Climate-related matters may also affect the measurement and classification of loans as lenders may include terms linking contractual cash flows to an entity’s achievement of climate-related targets. The lender will have to consider the loan terms in assessing whether the contractual terms of the financial asset give rise to cash flows that are solely payments of principal and interest on the principal amount outstanding. Those climate-related targets may also give rise to embedded derivatives that have to be separated from the host contract.IFRS 7 Financial Instruments: Disclosures requires entities to disclose the nature and extent of risks arising from financial instruments and how the company manages them. It may be necessary for lenders to provide information about the effects of climate-related matters on the measurement of expected credit losses or on concentrations of credit risk. For holders of equity investments, on the other hand, it may be necessary to disclose their exposure to climate-related risks when disclosing concentrations of market risk.Fair value measurementMarket participant views of potential climate-related matters, including legislation, may affect the fair value measurement of assets and liabilities in the financial statements. Climate-related matters may also affect the disclosure of fair value measurements where relevant, particularly those categorized within Level 3 of the fair value hierarchy.Since IFRS 13 Fair Value Measurement requires disclosure of unobservable inputs used in fair value measurements, those inputs should reflect the assumptions that market participants would use, including assumptions about climate-related risk.Insurance contractsSince climate-related matters can increase the frequency or magnitude of insured events, there may be an impact on the assumptions used to measure insurance contract liabilities. Similar to other areas, disclosure of the judgments made in applying IFRS 17 Insurance Contracts and relevant risks is required.Final thoughtsThe IASB document provides guidance to preparers of financial statements about the areas they need to consider in relation to climate-related matters. Although it does not introduce any new requirements, knowing how climate-related risks can impact financial statements can help remind its preparers about the scope of existing requirements in IFRS. This article is for general information only and is not a substitute for professional advice where the facts and circumstances warrant. The views and opinions expressed above are those of the author and do not necessarily represent the views of SGV & Co.Aris C. Malantic is the Financial Accounting Advisory Services (FAAS) leader of SGV & Co.

24 July 2023

Benjamin N. Villacorte

IFRS S1 and S2: Game changers in global sustainability reporting

The International Sustainability Standards Board (ISSB) published on June 26 its first two global sustainability reporting standards — IFRS S1 General Requirements for Disclosure of Sustainability-related Financial Information and IFRS S2 Climate-related Disclosure.These standards can be game changers by helping companies identify material sustainability risks and opportunities that will help investors, lenders, and creditors assess the company’s resilience against changes and uncertainties driven by sustainability-related issues. Through sustainability reporting, business leaders can future-proof their organizations and solidify their positions in the global market.IFRS S1IFRS S1 requires businesses to disclose information about their sustainability-related risks and opportunities to investors, lenders, and other users of general-purpose financial statements. This standard covers information about an organization’s governance, strategy, risk management, and the applicable metrics and targets for its identified material sustainability-related risks and opportunities. While the standard is supposed to become effective for annual reporting periods starting on or after Jan. 1, 2024, this will vary based on local legislation.Given how close this is, higher management may wish to consider the different variables when implementing IFRS S1, such as the breadth of information they will have to share with clients and investors.STRENGTHENING GOVERNANCEOrganizations operating in industries or areas vulnerable to climate-related risks may already be disclosing information about their board and management’s oversight responsibilities and risk assessment processes. However, it is important to consider that IFRS S1 covers many sustainability topics besides climate change. The standard underscores how boards oversee target setting and progress monitoring, whether sustainability-related risk protocols exist, and if these policies synergize with other internal functions. Businesses must bolster their governance and streamline processes to capitalize on IFRS S1’s potential. Additionally, organizations must install aptly skilled professionals to meet the standard’s sustainability-related requirements and realize their strategic vision.SUSTAINABILITY-RELATED RISKS AND OPPORTUNITIESCompanies are expected to report only material sustainability-related risks and opportunities in the first year of applying IFRS S1. Nevertheless, management may already wish to delineate a comprehensive set of risks and opportunities, as this will help organizations identify crucial metrics and targets. This also means that businesses should sufficiently plan and allocate resources, as the identification phase is imperative for sustainability reporting.When identifying sustainability-related risks and opportunities, IFRS S1 compels organizations to consider the IFRS Sustainability Disclosure Standards (IFRS S1, IFRS S2) and the industry-based Sustainability Accounting Standards Board (SASB). Companies can also analyze their competitors in the same industry or region to diversify their findings.Under IFRS S1, companies must share details about how sustainability-related risks and opportunities could affect their business model, cash flows, and strategic plans. This rigorous process demonstrates the relationship between sustainability issues and a company’s financial performance, giving investors a clear understanding of how environmental and societal factors could affect organizations.IFRS S1 uses the same concepts as the IFRS Accounting Standards, making it easier to integrate into future IFRS reporting. However, the scope for IFRS S1 differs from other sustainability reporting frameworks, so companies will have to first identify differences before applying the standard.HISTORICAL INFORMATION AND SUSTAINABILITY METRICSIn financial reporting, organizations generally utilize historical cost and fair value to measure the effect of events, transactions, and conditions in the financial statements. While accounting standards traditionally provide direct measurement guidance, the IFRS S1 does not. Instead, businesses must consider metrics from the SASB Standards and GRI Standards.IFRS S2On the other hand, IFRS S2 requires companies to disclose information specifically about climate-related risks and opportunities. IFRS S1 and IFRS S2 share the same content elements: governance, strategy, risk management, and metrics and targets. Similarly, the ISSB has set IFRS S2’s implementation date for annual reporting periods starting on or after Jan. 1, 2024, but, again, the effectivity date will depend on local legislation. Furthermore, the ISSB declared that organizations could utilize the standard earlier, but they must report their early adopter status and apply IFRS S1 at the same time.COMPREHENSIVE TRANSITION PLANSIFRS S2 categorizes climate-related risks as either physical or transitional. Physical risks are event-driven and longer-term such as extreme flooding and sea level rise, while transition risks are associated with moving to a lower-carbon economy such as higher operating costs as well as regulatory and reputational risks that will be faced by the company. Integrating transition plans into organizational strategies is becoming more important as the world continues to reduce carbon emissions. In line with this, IFRS S2 incorporates specific disclosure requirements about transition plans to help users understand the relationship between climate-related risks and opportunities and organizational strategy and decision-making.In addition, companies must declare the percentage of their assets and operations that are vulnerable to transition risks. Transition plans differ from long-term goals because the former is more comprehensive and detailed, such as articulating concrete plans like reducing greenhouse gas emissions. Organizations that already have transition plans must disclose critical assumptions, key activities, and resource plans.SCENARIO ANALYSES TO ENHANCE RESILIENCEInvestors will have access to more information given the requirements of IFRS S2, which could help them understand how companies adapt to disruptions related to climate change. Specifically, IFRS S2 requires organizations to articulate the durability of their business models to physical and transition risks. Hence, the standard mandates companies to perform climate-related scenario analyses and evaluations. Organizations should use suitable analysis methods based on their capabilities and resources.Conducting scenario analyses can help companies understand the resilience of their overall strategy to climate-related disruptions and uncertainties. Upper management will consequently gain salient insights to enhance their risk management procedures but should note that this is an iterative process that will require collaboration among the different business functions.REDUCE GREENHOUSE GAS EMISSIONSReducing greenhouse gas (GHG) emissions is crucial to climate change mitigation efforts. As such, IFRS S2 specifically requires organizations to disclose their absolute gross GHG emissions for the reporting period. GHG emissions are usually measured according to the Greenhouse Gas Protocol: A Corporate Accounting and Reporting Standard (2004). Given the undertaking’s complexity, IFRS S2 allows some flexibility with the organization’s measurement approach.If local jurisdictions demand that companies use a different measurement method, IFRS S2 will permit it. During the first annual reporting period, organizations will also be allowed to use another methodology besides the GHG Protocol if they already had an alternative approach for the period immediately preceding the standard’s application date.Organizations must engage their stakeholders to ensure proper systems and controls are in place to support their disclosures.AVAILABLE RELIEFSCompanies may take advantage of the available transition reliefs that the ISSB has offered to report preparers. This helps them apply the standards during the first year of reporting and facilitates the “climate-first” approach in its disclosures. Included in the set of reliefs is prioritizing and reporting only on climate-related information and publishing the disclosures together with the company’s half-year report. Issuers also need not disclose their Scope 3 GHG emissions, adopt the GHG Protocol, and provide comparative information to comply with the ISSB standards in its inaugural year of application.RELIABLE ORGANIZATIONAL SUSTAINABILITY REPORTINGIFRS S1 and IFRS S2 lay the foundation of global sustainability reporting. In this country, the Board of Accountancy (BoA) issued Resolution No. 44 on Sept. 8, 2022 which recommends the adoption of the ISSB Standards in the preparation of general-purpose financial statements and the renaming of the Financial Reporting Standards Council to Financial and Sustainability Reporting Standards Council (FSRSC). The FSRSC, BoA, and Securities and Exchange Commission will provide guidance on the definite dates of ISSB adoption for Philippine reporters. Consequently, FSRSC established the Philippine Sustainability Reporting Committee (PSRC) to evaluate IFRS S1 and IFRS S2 for local use and issue a local interpretation and guidance.While sustainability will likely remain a challenging topic, the ISSB Standards can be considered game changers in facilitating a better understanding of climate issues like global warming and their impact on the world economy. Effective leadership and board governance will be vital to driving accurate and reliable organizational sustainability reporting. By properly implementing these standards, organizations can stay abreast of disruptions and uncertainties while remaining competitive in the global market. This article is for general information only and is not a substitute for professional advice where the facts and circumstances warrant. The views and opinions expressed above are those of the author and do not necessarily represent the views of SGV & Co. Benjamin N. Villacorte is a partner from the Climate Change and Sustainability Services team of SGV & Co. He is also the chairman of the Philippine Sustainability Reporting Committee.

17 July 2023

Maria Kathrina S. Macaisa-Peña

Providing value for the tech-reliant consumer (Second Part)

Second of two partsAs consumers try to maintain their resiliency in the face of increasing cost of living pressures and ongoing economic concerns, they have started adopting new technology more frequently. This has led to consumers making changes in the way they consume, with the goal of making daily life more affordable through technology.In an SGV seminar held in June, “Getting ahead of the changing consumer and disruption, regional and local business strategy,” Climate Change, Sustainability Services and consumer products and retail (CPR) leaders from EY-Parthenon and SGV, along with distinguished industry leaders, shared the latest insights on the CPR industry. One of the topics discussed how companies can reframe corporate strategy to secure long-term sustainable growth for CPR, redefine the way they can serve consumers and anticipate sector disruptions, and embrace new-age models to get ahead of changing consumers.In addition, the most recent EY Future Consumer Index, which surveyed over 21,000 consumers in 27 countries, indicates that the usage of digital tools at work and home influences the way people consume as well as what they consume. This gives opportunities to businesses that can comprehend and influence these shifting consumer attitudes, but it should be noted that this goes beyond simply choosing appropriate technologies, overseeing their implementation, and developing the infrastructure necessary to support them.In the first part of this article, we discussed the technology-reliant and value-driven consumer as a result of the rapid rate of digital innovation and adoption, as well as the consumer’s issues with trust over the impact of new technologies.In this second part, we discuss how technological innovations must prioritize providing tangible benefits to the consumer, how technology will redefine the consumer of tomorrow, and how companies must build trust with, earn the respect of, and provide value to consumers.INNOVATION MUST PROVIDE TANGIBLE CONSUMER BENEFITSTo safeguard thin margins and market share, businesses are utilizing technology and data. They scramble to create data warehouses that they can mine for insights as consumers become more conscious of the value of their personal information. Consumers know the importance of their data, and demand better value as compensation for sharing it. The way businesses strike a balance in this dialogue becomes crucial to retaining customers.However, they must proceed cautiously since consumers are already trying out new brands and reassessing what they consider essential in their pursuit of better value. If consumers do not believe that using new technology benefits them, a company risks significant damage to the kinds of customer connections that are essential for long-term success and customer retention.The Index demonstrates a steady decline in the high levels of customer confidence many companies enjoyed following the pandemic. Retailers and consumer goods companies engage with customers far more frequently than other businesses, which presents an opportunity to either foster trust or undermine it depending on how well the needs of the consumer are taken into account.TECHNOLOGY WILL REDEFINE THE FUTURE CONSUMERThe way people live and work will change due to the rapid pace of technology, which will also redefine the future consumer. Behaviors and attitudes can suddenly and unexpectedly shift as a result of small, seemingly unrelated changes in many different areas.A majority of Index respondents — 50% — say they are employed by businesses engaged in large technology initiatives that aim to increase value for customers, employees, and investors. Artificial intelligence (AI) is one of the most important forces driving change in the technology landscape, and it will alter the customer experience with new products and services as well as completely new patterns of living and working on the horizon.BUILDING TRUST, EARNING RESPECT, AND PROVIDING VALUETo address their concerns about affordability, consumers are cutting back and reevaluating their priorities. While businesses must address these immediate requirements, they also cannot afford to lose sight of the wider picture. Future consumer behavior will be altered by technology, and businesses must therefore develop compelling value propositions that take this into consideration.Businesses must consider if consumers recognize the full worth of their brand or product, but also evaluate if this is what consumers want. The increased dependence on technology poses an opportunity for retailers and consumer goods companies to significantly impact the lives of their consumers, but it is just as crucial to provide them with advantages. For example, companies can provide a silent, time-saving convenience, or solutions to consumer issues that make certain products or services indispensable.Companies must consider how they can design gratifying, rewarding, and distinctive experiences, and determine how technology can assist in providing the optimal balance between all three components. For example, with environmental, social, and governance (ESG) as a major consideration these days, companies will also find opportunities to provide consumers with gratifying experiences by making conscious decisions in reducing the generation of plastic waste. Since both reduction and recovery methods are required to transition to a more circular economy, investment in technology, innovation, facilities, and product development are necessary.Also consider what steps are being taken to increase consumer confidence in the organization’s services and touchpoints, as well as how to determine if these efforts are effective. Trust involves many important factors, including providing value for money, protecting data, acting in accordance with the business values that consumers share, adopting an ethical mindset, and being genuine. Businesses can gain from a far deeper and more extensive interaction with consumers if they are perceived as one of a select number of reliable companies.Relationships like these are difficult to establish and simple to sever during a time when consumer confidence in businesses is experiencing a steady decline. Consumer-facing businesses have plenty of opportunities to get things right, but they also have as many opportunities to get it wrong because of the proliferation of new channels.Lastly, businesses have to ask themselves how they are adapting their strategies to address the technological revolution transforming customer engagement, and what they choose to prioritize. Innovation is transforming the propositions consumers have access to, how these are accessed, and ways of living and working. Businesses will need to respond to this by evolving the goods and services they provide, how they conduct business, and how they interact with customers.Businesses must also recognize, implement, and integrate the technologies that are appropriate for both the present and the future consumer. Despite the complexity, the objectives are clear: businesses need to build a relationship of trust, earn the respect of the consumer, and provide them with value that they will appreciate. This article is for general information only and is not a substitute for professional advice where the facts and circumstances warrant. The views and opinions expressed above are those of the author and do not necessarily represent the views of SGV & Co.Maria Kathrina S. Macaisa-Peña is a business consulting partner and the consumer products and retail sector leader of SGV & Co.

10 July 2023

Maria Kathrina S. Macaisa-Peña

Providing value for the tech-reliant consumer (First Part)

First of two partsThe emergence of disruptive technologies along with ongoing global crises are impacting the consumer product and retail (CPR) sector, and the consumer value proposition working today may not be successful tomorrow. With this in mind, regional and local business strategy, Climate Change and Sustainability Services, and CPR leaders from SGV and EY-Parthenon, along with distinguished industry leaders shared the latest insights on the CPR sector in a seminar on June 20, “Getting ahead of the changing consumer and disruption.”Additional EY research has also found that consumers are attempting to maintain their resiliency in the face of ongoing economic concerns and cost-of-living pressures. This has led to them adopting new technologies more frequently, making changes in the way they purchase, live, and work with the goal of making daily life more affordable.The most recent EY Future Consumer Index, which surveyed over 21,000 consumers in 27 countries, examines how consumers worldwide perceive the personal advantages of technology. Insights from the Index also show that the way people consume as well as what they consume is influenced by their experiences using digital tools. This provides opportunities for brands that comprehend and influence these shifting attitudes and foresee the potentially transformative changes these may bring. However, this goes beyond simply choosing appropriate technologies, overseeing their implementation, and developing the infrastructure necessary to support them.Digital innovation must safeguard and promote the relationship with the customer. Trust, respect, and value in particular are the key factors. Companies must show they can be trusted to use technology securely and responsibly and utilize technology to benefit their consumers. Any innovation a company implements must provide fair value to its consumers. Being unable to strike the right balance between the three factors can result in hard-to-fix damage. However, striking that balance successfully can strengthen relationships with customers and gain their consent to expand and deepen that relationship when new technologies become more widely used.TECHNOLOGY-RELIANT, VALUE-DRIVEN CONSUMERSThe rate of digital innovation and adoption has become so rapid that users can easily become reliant on new tools without realizing how integrated they’ve become in daily life. Consumers are relying on digital technologies more and more to simplify their lives, save time and money, work from home, or lessen their environmental impact. According to Think With Google: Year in Search 2022, a report that shares insights and trends based on billions of Google searches, Filipino consumers are turning to digital services such as electronic payments to simplify offline in-store purchases, as well as online doctor consultations to save time.Consumers use digital for a variety of purposes, including managing their finances, selecting what shows or music to enjoy, keeping in touch with friends, keeping track of their health, and many others. For instance, 42% of consumers use a smart device to measure their health and physical activity, and 33% of consumers use facial recognition on their mobile phones.This disruption from technology presents business opportunities across real and digital worlds, such as providing a seamless consumer shopping experience through an omnichannel, orchestrating a digital ecosystem to best serve consumers along the consumer life journey, and designing a new meta-retail experience through the metaverse. Olivier Gergele, APAC Consumer Products & Retail Leader – EY Parthenon, said at the CPR seminar, “Though the metaverse isn’t ready, it will change the way we do business. It will be especially important to know its implications for us as retailers in the industry.”People are also placing more importance on issues that directly affect them as individuals than those that feel like collective challenges, such as their concern for the environment. Many are trying to cut back on their expenditure, though how they handle their finances depends on where they reside. Consumers around the world are focusing even more on value, with 64% of consumers believing private-label products to be just as good as branded ones and 73% reporting shrinking pack sizes but unchanging prices.The Index indicates that consumers have drastically boosted their use of both established and developing technologies at work and at home during a time when consumers are more concerned about a wide range of economic and personal problems. There is a significant pivot toward two concerns in particular: finances and health.When using new technology to engage consumers, retailers and consumer product businesses should keep these financial and health concerns in mind. Digital innovation can play a significant role in enhancing organizational performance by maintaining competitive prices, identifying efficiencies, and enhancing marketing. Trendipedia 2023, a consumer behavior study conducted by Tetra Pak, identifies two new trends in the Philippines, Malaysia, Singapore, and Indonesia: “flexi-shopping” and “eatertainment.” In flexi-shopping, consumers adopt a flexible mindset and reduce spending when needed but indulge in additional benefits they deem valuable, such as those related to health. The eatertainment trend shows that consumers, particularly Gen-Zs, look to be entertained with new flavors and trends in the online space, which brands should explore to reach them.However, it is important to weigh the need to address any ongoing business challenges against a longer-term strategy that already considers the benefits brought about by ongoing technological change. Companies also need to be careful not to take any actions that will prevent them from participating in long-term progress for the sake of short-term advantages. Brands that let their customers down run the danger of losing future digital relationships with them, and consumers will be more likely to reject digital innovations that don’t provide them with what they want. To understand how consumers feel about the digital advances that are permeating every area of their life today, it is crucial to pay attention to how consumers perceive these advances.NEW TECHNOLOGIES RAISE TRUST ISSUESCustomers and new technologies often have contradictory connections — consumers can become very dependent on a tool while also expressing concern about the risks it poses to their psychological and financial well-being. For instance, people take for granted that their mobile devices are always connected, but at the same time, they want to disable notifications and reminders because they can find continuous connectivity to be too much.Familiarity by itself cannot establish trust. For example, the use of AI (artificial intelligence) is becoming increasingly popular in areas such as customer care and an increasingly common part of brand engagement for many consumers. Moreover, disruptive business models leverage AI capabilities for robust decision-making. For example, the CPR presentation at the SGV CPR event revealed that Amazon heavily relies on consumer data it obtains from its platform for marketing and personalization costs. These costs aim to attract a higher wallet share from consumers and increased consumer engagement. However, many consumers are apprehensive about how AI may be used, with 24% of respondents fearing it may fully replace their jobs.Though the availability and accessibility of digital innovation continue to grow, the same cannot be said for trust in technology and its usage of personal data. Each annual release of the Index has seen no significant change in the willingness of consumers to share data with companies or brands. Consumers remain wary over how much data they provide — as much as 55% say they are very concerned about identity theft and fraud, 53% are very concerned about data security/breaches, and 53% are very concerned about companies selling their personal information to a third party. This shows how much consumers want to weigh the benefits of sharing data against the risks and the value they receive in exchange.According to Ashish Midha, Managing Director and CEO of ZALORA Philippines and Indonesia, speaking at the CPR seminar, “What’s important is to show people what’s relevant to them. It is a very fine line to balance between personalization and privacy, and it should be value-adding to the customer. One can very easily do the wrong thing, so it’s better to err on the side of conservatism.”In the second part of this article, we will discuss how technological innovations must prioritize providing tangible benefits to the consumer, how technology will redefine the consumer of tomorrow, and how companies must build trust with, earn the respect of, and provide value that consumers will appreciate. This article is for general information only and is not a substitute for professional advice where the facts and circumstances warrant. The views and opinions expressed above are those of the author and do not necessarily represent the views of SGV & Co.Maria Kathrina S. Macaisa-Peña is a business consulting partner and the consumer products and retail sector leader of SGV & Co.

03 July 2023

Vicky B. Lee-Salas

Managing liquidity risk in today’s environment

After several years of abundant and cheap liquidity, banks are facing new liquidity risk management challenges in today’s rapidly changing environment. Between June 2022 and May 2023, the Philippine benchmark interest rate moved from 2.5% to 6.25%. Similar interest rate trends have been noted across the Asean markets, impacting bank balance sheets and creating tougher economic conditions for customers. Borrowers are dealing with increased loan payments on variable-rate loans, decreased savings rates due to inflation, and general uncertainty about economic conditions.The recent data are tracking significant growth in bank fixed-income securities investments, which are susceptible to unrealized losses in a rising interest rate environment. Securities growth was 60% from April 2020 to April 2023. Banks hold these securities to collect cash flows from interest and principal, but long-term securities with large unrealized losses are not typically sold to avoid realizing a loss. Thus, these investments do not represent true access to liquidity, unless banks undertake repurchase agreements at market value.Another factor driving up liquidity risk was demonstrated in the recent overnight failure of certain US banks. The sudden collapses show how, in the age of instant communication and social media, a financial panic can go into hyperdrive, facilitated by the ability to make instantaneous bank transfers and withdrawals.Although underlying problems caused the failure, banks need to recognize the additional liquidity risks now that social media has become interwoven into our social and financial lives. In an analog, bricks-and-mortar world, the US banks in question could arguably have had time to reach out to (and be propped up by) the Federal Reserve. But the speed at which social media fanned the flames of customer panic meant that, by the time banks opened the next morning, it was already too late to save them.Conditions can change quickly. Banks must stay on top of their liquidity management. TRADITIONAL STRESS-TESTING ASSUMPTIONSBanks need to take another look at their liquidity stress testing assumptions in light of:• The new speed of bank runs given the evolving role of technology in banking, including the ability of social media to turn a drama into a crisis. All the evidence suggests that a bank run precipitated by social media has the potential to cause even a healthy bank to fail in a matter of days.• The inflationary environment, with some observers predicting interest rates could climb into the low — or even the high — teens.• The potential need to support entities or funds, such as money market funds or unit investment trust funds (UITF), even though banks are not contractually obligated to do so.The new reality in which banks find themselves operating means current estimates of their contingency funding requirement may be significantly too low. They may also be underestimating the need to deal with intense media coverage or to incorporate reputation risk considerations into funding decisions. At its core, a contingency funding plan (CFP) is a crisis management tool. The plan should set out strategies management expects to use to address liquidity shortfalls. In this environment, now is a good time for banks to review their CFP and test its operational components.When updating stress testing, it’s vital not to ignore the worst-case stress tests. Monitoring and reporting functions are normally performed routinely, by the numbers on hypothetical, forward-looking scenarios. Management should look beneath the surface to highlight potential problems. Banks can no longer afford to “play it safe” with liquidity.The point is stress tests are not predictions. These are not events we think will likely eventuate. They are tools for revealing vulnerabilities — which means we must base them on worst-case scenarios. For example, what would the balance sheet look like if 80% of depositors pulled out their funds in a short period of time? It’s important to assess the impact of extreme but plausible scenarios like this on an institution’s earnings, liquidity, and solvency positions.SOLVENCY AND LIQUIDITY ARE TIGHTLY INTERTWINEDBanks also need to think more deeply about the link between their solvency and liquidity, which affects their liquidity buffer. The liquidity buffer is a pool of ear-marked, high-quality, and liquid assets used to meet immediate liquidity needs when faced with adverse conditions.Capital is not a substitute for liquidity. But the two are very closely intertwined. The more solvent a bank is, the less likely will a run ensue. Therefore, the weaker a bank’s solvency position, the more careful the bank has to be about maintaining a higher capital buffer.Apart from solvency concerns, the size of the liquidity buffer is also affected by a bank’s survivability horizon and risk appetite. The board should have a view on how long the bank is intended to survive a stressful environment when there is no access to new wholesale funding. Discussing these types of conditions will help to determine the size of the liquid asset buffer the bank needs. BUILDING LIQUIDITY RISK INTO DECISIONSIn tackling this issue, bankers should ensure liquidity risk strategies are clearly articulated and understood throughout the institution, especially in business units that generate and consume liquidity. This will help to drive corporate strategy that addresses liquidity risk and prudent business decisions. Otherwise, there may be gaps between business and financial plans, which can greatly weaken liquidity positions in the current environment.For example, institutions may not adequately prepare for the implications on the liquidity of actions taken in normal business activities, like focusing on a new customer segment, or strategic initiatives, like acquisitions or entering new markets. Liquidity costs must also be taken into account to more accurately reflect the true costs of products and services, leading to more appropriate deposit pricing.For banks looking to embed liquidity risk into day-to-day business decision-making, incentives can play an important role. Are targets sufficiently designed to achieve an appropriate balance between risk appetite and risk controls? Between short-run and longer-run performance? Or between individual or local business unit goals and firm-wide objectives?UNDERSTANDING BANK FUNDING RISKAn important piece of managing liquidity risk is to understand how the bank is funding its balance sheet. Normally, this involves a mix of core deposits, noncore deposits, wholesale funds and equity. Management should understand concentration risks, including large fund providers or large depositors, concentrations to certain industries, concentrations of noninsured deposits or concentrations in certain types of wholesale funding. Part of the CFP should be potential responses to those concentration and funding risks. Deeply knowing your customers and a study of historic deposit behaviors can also help the bank understand the expected maturities on its deposits. DATA QUALITY MAY NEED TO BE ADDRESSEDThe experience of helping banks to assess liquidity risk in institutions around the region highlights the need to address data problems. Accurate risk assessment depends on aggregating data across multiple systems to develop a group-wide view of liquidity risk exposures and identify constraints on the transfer of liquidity within the entire banking group.If banks are adjusting their stress-testing scenarios and assumptions, this is also an opportunity to check the validity and accuracy of data used in all reports feeding into liquidity risk management. Improving the accuracy of liquidity metrics and liquidity positions can identify significant liquidity opportunities.INDEPENDENT REVIEW OF LIQUIDITY RISK MANAGEMENTFinally, in a rapidly changing environment, an independent review can be helpful to evaluate liquidity risk management processes for their alignment with regulators’ guidance and industry sound practices.All these efforts will deliver strong returns on their investment. The better banks manage liquidity, the less it will cost — an increasingly important differentiator in today’s market. This article is for general information only and is not a substitute for professional advice where the facts and circumstances warrant. The views and opinions expressed above are those of the author and do not necessarily represent the views of SGV & Co.Vicky B. Lee-Salas is a partner of SGV & Co.

July 2023

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