THE END OF FREE MONEY AND IMPLICATIONS FOR THE BOARD
As interest rates rise to combat inflation, Boards are quickly moving to a different footing. The age of free money has come to an end with implications for financial services, as well as the real economy.
Fidelio clearly sees this in our Board Evaluations, as Boards reflect upon on their ability to provide guidance and leadership in a much less stable financial environment. We are also seeing the consequences of a higher interest rate environment in Fidelio’s Search practice, as Board composition acquires a sharper focus on capital markets, as well as M&A experience. There have been stark reminders that confidence in the Board is vital for confidence in the business with Board composition, including skill matrix and independence, coming under close scrutiny.
Extremely low interest rates were a constant companion in the years of turbulence following the Financial Crisis, followed by the global pandemic and the uncertainties of Brexit in the UK. These low rates enabled a certain set of financial and business choices which now require reconsideration. The war in Ukraine and a significant increase in inflation and borrowing costs have already pushed several banks to the brink and are putting significant pressure on other industries as well. The process of adjustment is being worked out across Boardrooms internationally.
LEVERAGE: NO LONGER THE PANACEA
Very low interest rates lower debt service costs and increase the attractiveness of leverage. During the period of “free money” borrowing was used in a wide range of sectors to boost equity returns and facilitate the payment of dividends as well as the buying back of shares. This was true in the listed sector, but also widespread in private equity. Higher debt service costs now make leverage less attractive, and looming recession has led to reduced confidence in the resilience of operating cash flows.
As a consequence, many companies are now reconsidering their portfolios and capital allocation strategies and are strengthening M&A and capital market skills on their Boards. This sharpening of focus is particularly acute in the real estate market, for example, where companies face structural change, with shifting demand and increased environmental standards, alongside higher debt service costs, lower property valuations, and an investor and lender focus on loan-to-value ratios.
CORPORATE STRUCTURES UNDER REVIEW
As a result of these factors, strategic reviews leading to portfolio restructuring and potential transactions are becoming more common. In addition, upheaval in some sectors is creating opportunities to acquire assets at attractive valuations: Board oversight and leadership benefits greatly from transaction skills, as well as experience in operational integration.
Investor activism is also on the increase after a relative lull during the pandemic, as explored in Fidelio’s recent webinar 'Pre-Empting Activism – the Role of the Board’. Structural simplification and a focus on core businesses is frequently part of the activist prescription, leading to potential transactions. And although investment banking activity is currently at a relatively low level, a resurgence is likely as the economic outlook becomes clearer.
IMPLICATIONS FOR BOARD COMPOSITION
In this unpredictable and volatile environment, Boards need to ensure that financing and capital structures are robust. Disciplined risk oversight has become paramount with echoes of 2008. But this also creates opportunities and the Board needs confidence that the company has the agility to identify and seize these, potentially at short notice. Some of the shotgun weddings in the banking sector will certainly require highly effective risk management and integration skills, but have the potential to create opportunity for the acquiror.
These considerations are clearly influencing Chairs as they think through composition, succession planning, as well as Board learning. Shareholders want to know that Boards are well placed to navigate this environment and Fidelio is clearly seeing this reflected in recent Board Search mandates, as well as priorities for upskilling.
The end of “free money” has increased the Board’s focus on ensuring that the capital structure is robust, and that relationships with lenders and investors in both equity and debt securities are well-managed. For several years banking skills in the Boardroom were less of a priority. This demand reflects the economic cycle, and recent interest rate hikes are clearly shaping Boardroom requirements, in particular for capital markets insight and practical experience of M&A transactions. Boards need to approve and guide strategic direction, and also have the ability to oversee progress and implementation.
Unlike some commentators Fidelio doesn’t see this prioritisation as a reversion from ESG. This agenda remains exceptionally important in the Boardroom and a critical aspect of ESG is access to capital. The turmoil created by interest rate hikes is accompanied by extraordinary societal and environmental change wrought by ESG and Boards need to be able to navigate both. Nor should progress towards greater gender and ethnic diversity on Boards be set back by financial uncertainty. The financial services industry has made considerable progress in developing diverse talent and leadership pools creating a strong source of future Board appointments. Fidelio remains fully committed to ensuring that diversity and the strategic alignment of Board composition, particularly in an age of sharply rising interest rates, go hand in hand.
For further information on how Fidelio can support your organisation in building Board capability, please contact Mark at mcumberlege@fideliopartners.com.
