Four takeaways for corporate boards from Sri Lanka’s crisis

Sri Lanka’s current crisis and its aftershocks, is ushering in an era in which Boards would need to get smarter on dimensions that may have been considered less important before

Sri Lanka’s unprecedented economic and political crisis, still unfolding, has not only exerted immense pressure on businesses, but also the governance of businesses – particularly, on boards. Whether an unlisted private company or family business, or a top listed corporate, director boards have had to contend with numerous macro and micro challenges over the past few years, coming to a head in early 2022 when the economic crisis reached a crescendo.

From managing the impact on workers and supporting their welfare, to navigating the changing regulatory climate and ad hoc changes in policy affecting business, the past year has been replete with new and evolving issues. This article reflects on four lessons/takeaways of the crisis for boards, and implications for the years ahead, based on the author’s personal observations.

Don’t ignore the macro

Sri Lanka’s macroeconomic conditions often take centre stage in and around the National Budget season. Before that, and for some time after that, much of it is forgotten or often relegated to general discussion before and after Board meetings. Today, there is heightened need to pay attention to the looming macroeconomic trends and challenges and their serious consequences. The effects of a large budget deficit for the future trajectory for interest rates, the effects of an exchange rate policy today on future availability of foreign currency in the country, the effects of a seemingly-attractive tax change now on future sovereign ratings, and so on.

Ignoring the macroeconomics is to the peril of any business. So, the Board conversation around these themes is essential. Management teams would no doubt consider some of these in developing their own business plans and growth strategies, however the nuanced and holistic perspective that a Board discussion on the macro can provide – in terms of deciphering possible pathways and the implications for the business – cannot be stressed enough.  

Increasingly, developing the ‘macro muscle’ in Boards, and consequently in the business, is vital. This can be done by way of having on the Board members who are formally trained or generally attuned to economic issues, or if not, inviting periodic presentations at the Board by external experts or macro forecasting firms.  

Board conversations on the macro conditions can also stimulate Key Management Personnel’s (KMPs) thinking of possible impact pathways, which they will then take back to their respective management teams to consider in business plans. Board conversations on the macro conditions can also help the Board itself identify some major near-term risks that need to be borne in mind and put in place appropriate resilience measures. This Board conversation should also be dynamic, in that it shouldn’t be artificially scheduled once every few months, but should be a point of regular check-in, so that any changes to the macro picture from one meeting to the next can be discussed and decisions based on it can be taken.

Different companies in different sectors would need to identify the ‘top priority’ macro factors that are most relevant for their specific type of business/sector and keep tabs on high frequency leading indicators on those. For instance, in financial services companies like insurance and fund management, the interest rate is critical and keeping an eye on weekly Treasury auction subscriptions and rates, private sector credit growth, and spreads between AWCMR and SFDR/SFLR can all help anticipate shifts in long term rates.

Guide scenario-building and test assumptions

Another key aspect, somewhat linked to the above, is building up scenarios and conducting stress-testing. It is common for financial services firms to conduct stress-testing on key metrics of stability and profitability, for instance to regularly check solvency and capital adequacy under different scenarios. This is needed in other firms too, to ensure that key performance and stability metrics of the business can withstand a variety of different macro shocks. In turn, testing the underlying assumptions of these stress-test scenarios are also important – and for this, the Board can question and guide the management (as well as seek external input from analysts).

During my time at the Ceylon Chamber of Commerce as its Chief Economist, I often felt that too many top businesses and their leaders tend to take a lot for granted and assume that things will work themselves out. While it is well known that economists can be great purveyors of doom and gloom and not everything we forecast may come to be, I noticed a tendency to ignore scenarios completely as being ‘alarmist’ or ‘too far-fetched’.

If Boards insist on seeing the management present different scenarios and assign probabilities to them (high, moderate, and low likelihoods), at least the Board can be confident that both the realistic scenarios as well as those that may be ‘too far-fetched’ have at least been considered. An additional aspect to the scenario-building point, is about the Board working closely with the company’s risk unit (often through a Board Integrated Risk Management Committee) to continually test and refine the frameworks and assumptions being held in the management’s scenario-building.

Sometimes the Board may advise that those frameworks be externally/independently tested and verified from time to time, to check that they hold up to added scrutiny. Even as there are mixed expectations on the likelihood of domestic debt restructuring, Boards of businesses holding government securities would need to – in the very least – prepare different scenarios around the impacts on their capital and profitability under different types of restructuring (for example, maturity extension and/or coupon reduction).

Other scenarios that have come to the fore involve times of crisis, for instance, a pandemic or natural disaster. As one global board director noted in a report on COVID-19 and boards, “Many of the risk matrices we had looked at as a board were not useful when the pandemic hit. We had not planned, even non-specifically, for a situation in which we did not have access to our employees”. The scale and scope of the pandemic has changed how directors are thinking about operational risks and risk matrices. It has made Boards pay much greater attention to business continuity and disaster recovery exercises more than before, and beyond just routine drills. Board would need to work with their Managements to develop scenarios around what is sometimes called ‘unknown unknowns’, not just the ‘known unknowns’.  

Overall, the Board would need to guide risk units of corporates to conduct smarter scenario building. This would need to evolve beyond the standard approach of having a binary ‘yes’ or ‘no’ scenario and the Board should support evolving the risk unit to a risk management function, where risk is identified and graded as risks to be avoided, risks to be mitigated, and risks that can be reasonably ignored. Having concise and clear dashboards on these at Board level would be important. Often, reviewing these are delegated to a Board sub-committee on integrated risk management. While such sub-committees would take the lead, there is a fine balance here and the Board should avoid a situation where the rest of the board relinquishes some ownership over risk due to the delegation.

People focus and managing sensitivities

 Both through the pandemic and the ongoing economic crisis, the debilitating impacts on workers and their families have come to the fore. The rising cost of living (with consumer price inflation now topping 60%), the shortages in key essentials for the household, and strains on families due to work from home, transportation issues and elder care, have placed heavy burdens on employees. In many companies, management – in consultation with the Board – have pulled out all the stops to support employees financially and in kind.

A key role I see for Boards in this, is to ensure that any financial and in-kind schemes that the management devise are a) sufficiently generous and meaningful to meet the current needs; b) are formulated (and indeed communicated) carefully so as not to create rigidities that would be difficult to roll-back later once conditions normalise (benefits and bonuses are often ‘sticky downwards’), and are c) designed bearing in mind not just a narrow type or grade of employees, but also those who might live different lifestyles or have different consumption patterns to the average manager.

On this third point, for instance, a Board discussion with people from multiple perspectives can help inform whether an in-kind scheme should be for grocery vouchers from a higher-end supermarket with limited outlets, or one that is more modestly priced with a much wider spread of outlets and easier access. Sometimes the Board can, given their wider engagements in other circles, bring new perspectives to bear on the benefits being formulated – for instance, guiding the management on different socio-demographic sensibilities as well as reputational sensitivities to consider.

Taking a stand

During the economic and political crisis in Sri Lanka during April to July 2022, we saw a slew of corporates releasing various forms of statements – some called for solidarity with protestors, others calling for calm from all sides or urging swift resolution of the crisis. In a few instances corporates put out unambiguous and bold statements, whereas others were quite tepid and meaningless. The latter arguably caused more reputational damage, as young people took to social media to call those corporates out. In an era of heightened scrutiny and public attention on the nexus between business and governance, corporates’ Boards – not just their communications and public affairs teams – should play a key role in considering what the purpose of such statements would be and what the tone and timbre that the company should take.

This is vital given that it has reputational consequences and would influence not only the perception of the company in the eyes of government and regulators, but also in the eyes of employees, customers, and the wider public. Perfunctory statements can be damaging. Boards should carefully consider whether taking a public stand is timely and appropriate, and if doing so, then whether it is perfunctory or has real meaning. Boards can also consider whether it makes sense to take a public stand alone or take it through a business grouping (like a chamber or trade association) it may be part of – there could be merits and demerits in either option. A rule of thumb for the Board should be – if you don’t have something authentic to say that resonates with the actual purpose and lived values of the company, it’s best to not say anything at all.

Thoughts ahead

Different Boards are run differently, and the relevance of the above four lessons or takeaways would have different implications depending on the ownership structure, governance, and values of the company. Nevertheless, what is clear is that the forthcoming period ahead for the Sri Lankan economy will be fraught with challenges, uncertainties, and new pressures. Just like how COVID-19 ushered in a new outlook for Boards’ role and approach, Sri Lanka’s current crisis and its aftershocks, is ushering in an era in which Boards would need to get smarter on dimensions that may have been considered less important before.

(The writer is an economist and Co-founder of the Centre for a Smart Future, a think tank (www.csf-asia.org). He serves as an independent director on the boards of three financial services companies and chairs the investment committee of a high-net-worth family office. He is also the Chair of the Young Directors’ Forum of the Sri Lanka Institute of Directors (SLID).)