Suits the C-Suite

04 September 2023

Anurag Mishra

How generative AI can reshape the financial crime landscape

Financial crime is estimated to cost $1.4-3.5 trillion worldwide. With sophisticated methods deployed by criminals, government, regulators, and law enforcement often play catch-up to maintain trust in the financial system. There is an increasing need for change and innovation to tackle financial crime. Generative artificial intelligence (GenAI) has transformative capabilities for organizations, with business applications evolving rapidly. The financial industry is an early adopter of technology and is witnessing the increasing application of GenAI in fraud prevention, anti-money laundering (AML), counter terrorist and proliferation financing (CTPF), and cyber security, collectively referred to as FinCrime.THE CASE FOR GENAI ADOPTIONGenerative AI (GenAI) can boost efficiency across AML controls, allowing individuals to play a more prominent role in detecting and preventing FinCrime. Different entities are experimenting with large language models (LLMs), with results underscoring opportunities for FinCrime operations. LLMs are a type of AI algorithm that uses massively large data sets and deep learning predictive techniques to understand, summarize, and generate contextual content. GenAI is not limited to text, but can be used to extract, analyze and classify data, and augment case summaries.GenAI can train on large real-time data sets that include both normal and anomalous transactions, and can then perform statistical analysis to determine what is normal and what is anomalous.GenAI models can analyze behavioral data and process enormous amounts of customer transaction history to identify unusual events. Different fraud detection models can be evaluated to proactively detect emerging fraud patterns. GenAI can automatically flag a suspected fraud when deviations are found and trigger a case examination. This reduces the manual effort required to retrieve, analyze, and present case summaries for decision-making.Think of GenAI augmenting case examiners to detect fraud as it occurs, make faster and value-making decisions to prevent fraud, and reduce human error and biases.It is much easier to personalize fraud detection models to customer personas with GenAI. This not only allows for a personalized banking experience but also makes it harder for criminals to scale and exploit weaknesses in the system. Eventually, GenAI can generate insights to strengthen FinCrime controls. This helps banks stay ahead of the curve, detect, and prevent fraud.Malicious fraudsters are also employing GenAI technology to launch highly personalized and specific attacks on their victims. For example, fraudsters could use GenAI to analyze publicly available information and simulate fake accounts, e-mails, and calls. As such, the technology can also increase individual and organizational vulnerability and susceptibility to fraud.In the complex, digitally connected world, FinCrime poses systemic risks to the global economy. Business leaders can stay abreast of potential risks and respond with the power of GenAI to fight FinCrime. TURBOCHARGED FINCRIME CAREERSFinCrime operations are currently overly complex and manual. Detecting and preventing FinCrime is an onerous task compounded by complex policies, legacy technology, and inaccurate, voluminous and unstructured data. However, with GenAI, FinCrime roles are being elevated to the equivalent of the superhero status of saving the world in the following ways:• Auto-detection of FinCrime will reduce manual effort.• GenAI-generated case summaries will reduce manual effort and allow focus on investigation and decisions, solving and preventing FinCrimes.• Automated monitoring removes stress and allows focus on decisions and actions.• Remove the siloed view of fraud. Transactions occur across different product types, instruments, and modes. With GenAI, it’s possible to have one collaborative, informed view of customer and rogue transactions that are in deviation.• Regulatory changes and policies can be easily applied across customers, products, and modes of banking. Less time is required for compliance reporting to regulators.• Anxiety of human oversight gets eliminated with better insights and traceability.• Generates high-skilled jobs based on the interpretation of insights and faster augmented learning.• Better risk assessment, response, and efficient management.• Greater adaptability to changing strategies of criminals and fraudsters, ensuring trust in the financial system.GenAI can supplement risk assessments and detection. While FinCrime experts will still have to manage the output produced, they will have more tools and information to analyze the results, detect FinCrime, and safeguard against risk.While the technology significantly enhances organizations’ capacity to respond to FinCrime, employees and leaders should train on new skills, embrace collaboration of AI with humans to turbocharge outcomes and learn to deal with ethics, fairness, privacy, and AI-related bias and concerns.THE FUTURE OF FINCRIME AND GENAIFighting FinCrime was hostage to intrinsic human inefficiency, manual errors, and administrative burden. However, GenAI is empowering FinCrime fighting efforts with unprecedented speed and effectiveness. By utilizing LLM tools, professionals can seize opportunities to strengthen and expand the field.While GenAI has considerable promise, it may take time for specific industries to adopt the technology on a large scale. Consequently, organizations should delineate ethical considerations and data protection policies to safeguard their assets while capitalizing on the technology’s power.As FinCrime continues to evolve, business leaders must find the balance between efficiency and effectiveness, especially when dealing with risk. Organizations must be vigilant and utilize novel tools and technologies to adapt to and safeguard against the evolving digital landscape. Companies can remain competitive in the global market by seeking the advice of professionals with a deep understanding of FinCrime and AI and identifying GenAI-related opportunities and risks. 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.Anurag Mishra is a Financial Services Organization Technology partner of SGV & Co.

28 August 2023

Alden C. Labaguis

Megatrends impacting indirect tax

Indirect taxes, such as value-added tax (VAT) and customs duties, are the types of tax that may be shifted or passed on to the buyer, transferee or lessee of the goods, properties, or services. Indirect taxes are levied on goods and services (or consumption), whereas direct taxes are imposed on income and profits. Governments are now turning to indirect taxes to fill their revenue gaps as a result of the pandemic’s severe budgetary pressures.In a challenging year for the global economy, trade, transformation, and sustainability are three megatrends influencing indirect tax policy. While these megatrends are pressuring indirect tax teams to be flexible, use technology to adapt, and do more with less, these trends also provide opportunities for indirect tax and customs functions to help their organizations succeed.Indirect tax is receiving more attention as a result of global economic and geopolitical challenges. VAT/sales tax, excise and customs duty, and environmental taxes are becoming more demanding on a global scale. Governments are also leveraging tax and customs policies to advance political objectives and promote change in fields like sustainability.This has resulted in significant legislative change, additional obligations, and an increased emphasis on technology to support tax and customs compliance processes. Effective indirect tax management is more important than ever to control cash flow, costs, and the risk of audits and legal action from tax and customs authorities.TRADE DISRUPTIONGlobal trade and supply chain activities are inextricably linked to indirect taxes, which are significantly impacted by changes in the way businesses conduct their operations. Changes in these taxes could also significantly impact the supply chains of businesses.The disruption of trade has been a recurring trend in the last year; contributing factors include the war in Ukraine, the ongoing consequences of the pandemic, trade conflicts, new trade agreements and alliances, and a quickly changing regulatory environment. However, the trade function has never had such a strong opportunity to improve the performance of the company or been in such a strong focus than now.Indirect tax and customs functions can take action in the face of geopolitical uncertainty to remain agile while navigating disruptions, including driving out unnecessary duty costs, concentrating on cash flow, delivering cost-efficient tax processes, and using data analytics to compare indirect tax costs and opportunities from new supply chains.In the Philippines, in addition to the tax authorities’ resumption of audit investigations, there is an additional challenge of simultaneously managing the customs authorities’ intensification of post-clearance audits — which are geared towards sustaining increased revenue collection even after clearance of imported goods at the border. TRANSFORMATIONRising complexity, regulation, as well as the competition for talent are contributing to transformation, but technology is the main motivator. Tax and customs authorities all over the world are quickly embracing technology and automating manual procedures. They are demanding real-time transaction data, and several jurisdictions are starting to employ e-invoicing and real-time reporting. In the Philippines, this is consistent with the tax authorities’ adoption of the electronic invoicing and receipting system, which requires certain taxpayers to electronically report their sales data. Upon establishment of a system capable of storing and processing the required data used by electronic point-of-sale systems, certain categories of Philippine taxpayer will be required to use such electronic systems.In a mid-year report, Philippine customs authorities showed they are not far behind, highlighting programs focusing on digitizing customs processes, revolutionizing operations, and enhancing trade facilitation. Advanced information communication technology projects are lined up for implementation, such as automated export declaration and overstaying container tracking systems, among others.As a result, tax and customs authorities will have increased visibility on how businesses operate on a day-to-day basis, placing additional responsibility on corporations to enhance their data collecting and management. This frequently necessitates identifying data across the company and even throughout the supply chain as new taxes and reporting requirements are implemented.These demands are being made at a time when tax departments are under greater pressure to increase efficiency and provide genuine value. Along with effectively utilizing current technology, indirect tax teams must assess the need for extra resources and determine the right balance of in-house and outsourced work for their organizations to satisfy these demands.In order to help drive transformation within their own organizations, indirect tax and customs functions must become future-proof by implementing a data strategy, harnessing the right technology to support their operating model, creating a tax governance structure that defines responsibilities, considering a centralized approach to VAT management, and using the implementation of tax policies to address long-standing data issues.SUSTAINABILITYGovernments, businesses, and individuals around the world are prioritizing climate catastrophes and the need to safeguard the environment and human health. Governments are relying more on indirect taxes to support their environmental, social, and governance (ESG) initiatives, and indirect taxes are raising revenue to help fund green policies. New green taxes are also motivating people and companies to make the necessary changes in order to achieve sustainability goals.The functions of tax and customs are put under pressure by ever-evolving tax and customs regulations. They need to be aware of the taxes that are applicable to their companies, how to comply with their commitments, and how to account for them in costing and supply chain choices. As an example, they can assist in lowering expenses, reducing compliance risks, and finding opportunities for grants and incentives to finance green investments.Indirect tax and customs functions should consider understanding their organization’s plans to achieve its climate ambitions and get involved, as well as measure the impact of sustainability taxes and related policy measures on operations. Other key sustainability actions include identifying tax credits, grants, and incentives that will support the organization’s green agenda, assigning clear responsibilities, assessing exposure and liaising with relevant stakeholders within the value chain, and planning and implementing responses to the new measures impacting the business.THRIVING IN TRYING TIMESLeaders in indirect tax have never had a better chance to add more value to their organizations. By utilizing their abilities, creating connections within the organization, and utilizing innovative technology, they can bring about positive change and produce significant results.It is imperative that they take into account the bigger picture and how the megatrends of global trade, transformation, and sustainability affect the indirect tax function. This will allow them to better frame the indirect tax issue inside their organizations, navigate hurdles, and seize opportunities that will benefit the whole organization and allow it to thrive instead of merely surviving in trying times. 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.Alden C. Labaguis is a tax principal of SGV & Co.

21 August 2023

Christian G. Lauron

How generative AI creates value for financial services

The artificial intelligence (AI) landscape is constantly evolving, and large language models (LLMs) have gained global traction for their bespoke capabilities. Notably, ChatGPT reached 100 million users merely two months after its launch, making it the fastest-growing application in history. These developments showcase generative AI’s abilities, pushing the boundaries of what technology can do with text and language.However, the utilization of LLMs is controversial and has been the subject of debate among academia, regulatory bodies, and the general public. Skeptics point to hallucination as a significant drawback of AI models, which would be pronounced in cases where the model provides responses based on pattern recognition rather than reasoning. Various entities have urged the government to hasten AI-related regulation in response to the extensive adoption of generative AI models. Moreover, there are significant concerns with privacy, security, trust, and reliability. There is a serious threat of ‘model collapse’ when the knowledge base underpinning generative AI systems is inundated with imperfect information, deliberate misinformation, and uncontrolled synthetic data. The proverbial GIGO is at play — garbage in, garbage out.Despite these apprehensions, generative AI is a comprehensive technology that can transform work for different sectors. Corporations have been rapidly spending on AI, with several industries investing considerable time, money, and resources. While some organizations are moving at a steady pace, others have shared a multiyear commitment to integrating this technology across their functions. While there are sectors that find the current imperfections of generative AI unacceptable, there are those, such as financial institutions, that have actively experimented and deployed use cases in lower-risk areas.THE VALUE PROPOSITION FOR FINANCIAL SERVICESWhile banks and financial institutions have already been utilizing AI applications for different areas like credit risk and fraud, generative AI could further enhance other services, streamlining a broad array of business functions and uses that can elevate core offerings. Several applications and functions are suitable for AI adoption, including customer marketing, insurance claims processing, and financial planning. Internal services like application development, compliance monitoring, and maintenance also have potential.Technological advancements help expand business-use cases, particularly when dealing with unstructured data like text. Thus, organizations can create or refine business content using generative AI’s ability to query data in a natural, humanlike manner. However, the technology is still in its nascent stage, meaning AI should be synergized with human expertise to generate accurate insights and create long-term value.OPERATIONAL EFFICIENCY AND AUGMENTED INTELLIGENCE Financial services firms could slowly integrate AI in lower-risk areas like augmented intelligence and operational efficiency to minimize risk. Differing views have tempered AI adoption, but organizations have been experimenting with various use cases due to the technology’s reported benefits and strengths. To retain their competitive positioning, firms should assess and leverage AI in controlled environments.Operational efficiency involves enhancing productivity and reducing costs by automating tasks like information categorization, review, and synthesis. On the other hand, augmented intelligence entails assisting experts by providing content, insights, and recommendations for clients.CROSS-FUNCTIONAL CAPABILITIESIn the following areas, AI can support operational efficiency, reallocating human effort to other critical tasks:Tax and legal. Augment tax file generation, streamline contract organization and refine diligence processes for legal teams.Product, technology and IT. Create new product or service functionalities, generate natural-language-based code blocks and make test cases for evaluating code vulnerabilities.Risk and compliance. Map risk controls with corresponding regulations and flag missing disclosures or regulatory risks like fair customer treatment and sales practice concerns.FUNCTIONAL SOLUTIONSGenerative AI can also be leveraged in the following functions to streamline operations and innovate new ways of doing business:Chatbots and virtual assistants. Provide tailored, end-to-end support using natural language. Specialists can configure this functionality based on internal or external knowledge or information, subject to the organization’s discretion.Knowledge management and generation. Appropriately sift through and retrieve institutional knowledge and intellectual property. Organizations can utilize generative AI to augment and create content based on internal or external knowledge databases.Document intelligence. Execute advanced information extractions from unstructured or semi-structured data formats. The process can also focus on specific attributes and elements or generate insights from available information.THE FUTURE OF AI IN FINANCIAL SERVICESGenerative AI has the power to transform businesses. For financial services firms, transformation entails capitalizing on the technology’s strengths while managing the corresponding risks. Successfully creating value from AI involves a synergy between the latest technology and an organizational culture that invests in various capabilities and develops a framework for risk management.The financial services sector has a head start with deploying generative AI, given its experience with navigating AI-related regulation. Hence, many financial institutions have become market leaders in devising an AI governance framework, which includes setting policies, standards, and procedures. In the same vein, other industries and organizations should address critical areas like AI governance and oversight frameworks when integrating this technology into their operations.Lastly, effective board governance is crucial for the management of generative AI.While these practices will need to be polished and redefined, financial services institutions should use this time to identify and invest in potential applications for the technology. Organizations that successfully integrate generative AI into their organizational makeup can differentiate themselves and remain competitive. 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.Christian G. Lauron is the Financial Services Organization (FSO) leader of SGV & Co.

14 August 2023

Lee Carlo B. Abadia

Transforming with AI

The science for artificial intelligence (AI) has been around for almost a century. Although the concept of AI can be traced back to ancient stories from Greece and China, AI practitioners have only actively achieved significant progress within this century. The approach to applying AI has been continuously refined, from using symbolic or classical AI that is based on embedding knowledge and creating rules, to progressing statistical AI which involves pattern recognition, probabilities, and learning. Nonetheless, the challenges encountered in applying AI have forced renewed thinking among practitioners.With computing power increasing exponentially over the years, the discipline of AI now has an explosive opportunity to grow whatever the approach may be, but largely towards practical use cases. In addition, the growth of AI would not be centered solely around creating robots that think and behave like human beings, as is often portrayed in movies and books. Instead, it will revolve more around how it can fulfill specific objectives as agents in various forms to help humans achieve their work. This is where the current boom is coming from, but this unfortunately also raises concerns related to how AI may replace some jobs. On the other hand, there also are many who are actively pushing and exploring the possibilities for AI to make work more efficient for people.In the recent EY Tech Horizon report, where about 1,600 companies across the globe of varying sizes were surveyed quantitatively and qualitatively, respondents reported that AI and machine learning will be a significant part of their top technology investments within the next two years. AI can be considered a foundational technology, along with data and analytics, the cloud, and the Internet of Things. By combining these four as part of their technology strategy, organizations gain a good foundation to execute a tech-enabled transformation. As AI continues to gain more traction in development and adoption, however, its prominence as an expected technology stack will likely increase.CHALLENGES IN AI ADOPTIONThe recent Forrester’s Global AI Software Forecast predicted that off-the-shelf and custom AI software spend will double from $33 billion in 2021 to $64 billion in 2025. Moreover, AI software is projected to have an annual growth rate of 18%, which is 50% faster than the overall software market. However, based on one IDC survey, only 22% of organizations in 2022 reported that AI was implemented on a large scale in their enterprises.For all the reports around how AI will be a priority for investment and implementation in organizations, we have yet to see it leveraged at scale to transform businesses. This poses the question — why is AI, which is clearly a top-of-mind technology around the world, seemingly unable to make a strong breakthrough?A key challenge for widely adopting AI across an enterprise is the typical bottom-up approach taken by organizations. It often starts with technical teams building portfolios of projects on piloting AI on specific processes only, which is disconnected from the wider business. This creates siloed solutioning and tends to put the burden on technical teams to foster the business cases for AI to incrementally secure more funding. This also means that solutions may not look holistically at how the business works and can lead to an incoherent approach to delivering value across functions. This incoherence can lead to leadership and teams being disillusioned with what AI promises to deliver.Maximizing the potential of AI requires a refreshed approach. Businesses should include this as a strategy from the top to help differentiate themselves from competitors while simultaneously becoming more resilient to disruptors in their industry. Chief Executive Officers (CEOs) should drive the change in culture towards AI and align with their Chief Information Officers (CIOs) towards championing the importance of technology in meeting organizational goals.This means that there should not be a separate technology strategy, but one embedded into the business strategy itself. This approach can help answer questions such as whether AI allows the organization to enter a new market or re-imagine its business model. This will ensure that investments in technology will align and help meet the vision of the organization.LEVERAGING AIAs early as the 1970s, one of the first recognized knowledge systems (classical AI approach) was MYCIN. This system was intended as a doctor’s assistant refined over a period of five years and was designed to give input and explanations about blood diseases based on blood tests.The use of AI has since been developing across various industries and businesses should be more aware of how it can be deliberately leveraged while being driven by an organization’s leadership. The most common use is enabling it as a recommendation engine for online retail or search, which by now should start being a standard for most online stores.Fast forward to now: machine learning (statistical AI) can help identify diseases in medical surgery, from CT scans used to detect lung cancer to eye photographs to check for diabetes. Another example is in smart farming, where crop scanners and drones collect images and analyze them to determine if more water, pesticide, or fertilizer is needed. In short, regardless of the industry, AI can drive innovation to help humans.AI can clearly help enable CEOs innovate, but with it comes the responsibility of proper implementation. There are issues such as data privacy, embedded biases, and accountability in deploying this technology. While the strategy is defined from the top, along with it comes the necessary governance to help safeguard the organization from its risks. In 2023, seven leading AI companies in the US have agreed to voluntarily implement safeguards on AI development. They have committed to establishing new standards for safety, security, and trust for the technology.Being familiar with these movements can help business leadership navigate where to plan for AI adoption, and check for readiness on how to address potential regulations in their industries.EMBRACING THE IMMINENCE OF AIWe have come to a point in history where AI can be deployed as a day-to-day technology. This was made possible because the science now focuses more on specific use cases rather than creating general AI that strives for human-like intelligence. AI is going to be an imminent part of how businesses will be run today in the same way that machines in the industrial revolution moved workers from cottage industries to industrial factories and introduced new skills for people.CEOs must embrace this imminence and can do so by intentionally including this in their high-level strategy, understanding how the technology can be applied today, upskilling employees to work with AI, and more importantly being proactive on internal governance and external regulation. 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.Lee Carlo B. Abadia is a technology consulting principal of SGV & Co.

07 August 2023

Aris C. Malantic

Reframing the CFO role

In today’s fast-evolving business environment, chief financial officers (CFOs) face myriad challenges such as driving long-term value, finding short-term cost efficiencies, and reinventing the finance function while grappling with complex and conflicting expectations from stakeholders.According to the 2023 Global EY DNA of the CFO report, CFOs and finance leaders have the potential to unlock more value if they can adeptly address three fundamental paradoxes within the CFO role: balancing near- and long-term investment priorities, balancing risk with innovation and transformation, and balancing the evolving CFO role with traditional skill sets. This article examines these issues using insights from 110 respondents in Southeast Asia, including finance leaders from the Philippines, Indonesia, Malaysia, Singapore, Thailand, and Vietnam.NEAR- AND LONG-TERM INVESTMENT PRIORITIESSome 84% of the Asean finance leaders surveyed say that the current market environment is putting increasing pressure on finance leaders to drive cost efficiencies and hit short-term earnings targets. This results in finance leaders having to pause or cut spending so that they can meet short-term earnings targets in areas that are also priorities for long-term value.The Asean respondents in the study rate the top three investment priorities driving long-term value as: technology and digital innovation (57%), ESG programs (50%), and customer experience and product and service offerings (47%). At the same time, more than 30% say they are pausing or cutting spend in these areas to meet short-term earnings targets.While balancing long-term with short-term priorities is a collective effort, 65% say that there are disagreements and tensions within their leadership team on how to balance these priorities. A CFO with the influence and credibility to challenge the CEO and executive team will likely be needed to build consensus, but finance leaders are not always prepared to do so. Only 38% of the respondents say they always speak up when they have a differing opinion from the consensus when the executive team is deciding how to balance short- and long-term priorities. For CFOs to effectively influence the executive team’s decision-making, the top two attributes identified are: using data-driven insights to inform decisions and trusted relationships with the board or key investors.BALANCING RISK WITH INNOVATION AND TRANSFORMATIONAsean CFOs are building digitized finance functions to drive long-term and sustainable growth. They identified the following top three priorities to transform their finance function over the next three years: technology transformation (such as transforming IT architecture, building cybersecurity resilience, and modernizing core finance technology), sustainability (such as building skills and capability in ESG data controls and assurance), and advanced data analytics (such as unlocking the value of financial and non-financial data to transform decision-making). However, only 17% of respondents say they deliver “best-in-class” performance when it comes to assessing how their finance function today performs against these priorities.Even though there is significant room for improvement, only 14% of respondents are making holistic and bold changes to transform their finance function. This could indicate potential tension in the CFO’s mindset: a conflict between a risk-averse nature versus the need to embrace greater risks associated with an ambitious vision for a leading finance function.BALANCING THE CFO ROLE WITH TRADITIONAL SKILLSThe survey also reveals a difference in the long-term career goals of respondents: 42% say the CFO role is their long-term goal, while 48% aspire to an even greater CEO role, whether in their current organization or in another. This aspiration to be CEO raises two key considerations: the need for finance leaders to elevate their skills, and the importance of developing the next generation to fill the CFO role when incumbents move to a CEO position.The respondents identified two key challenges in achieving their priorities: finding time to build knowledge and expertise through exposure to external expertise and thought leadership access, and managing a wide range of operational responsibilities, including IT and HR. These challenges can be interconnected — as CFOs expand their operational responsibilities, they need to expand their knowledge beyond finance by acquiring skills in fields such as HR and marketing. However, their busy schedules may hinder their ability to invest in building this knowledge.The evolving expectations for CFOs to expand their knowledge in other domains highlight a shift from domain expertise toward inspirational and strategic leadership skills, going beyond traditional finance skill sets. The study also highlights the importance of highly developed emotional intelligence and experience in people issues like diversity and well-being, which was chosen as the most critical attribute for the successful CFOs of tomorrow.At the same time, incumbent CFOs must prioritize developing the next generation of leaders. Asean finance leaders feel that they perform well here, especially when it comes to mentoring — as much as 64% say they are investing enough time in mentoring aspiring senior finance leaders.REFRAMING THE CFO ROLE FOR THE FUTUREAs CFOs confront the abovementioned issues, they should consider the following:Create value for the whole organization. CFOs must articulate a comprehensive strategy that maximizes long-term value while being supported by short- and medium-term objectives. They must also provide data-driven insights to support the organization’s strategic objectives and build relationships with C-suite colleagues and senior leaders.Drive the performance of the finance function. CFOs need to drive cultural change across the finance team to elevate the performance of the finance function. This can mean embracing new mindsets and incorporating cultural goals into leadership and incentives. Also, they can consider revising hiring, development, and upskilling approaches to future-proof finance skills. This may require assessing the current workforce to identify gaps and surpluses and implementing an appropriate workforce strategy.Achieve career ambitions while developing future CFOs. CFOs should focus on achieving their career aspirations while also nurturing the CFOs of tomorrow. External stakeholder engagement is imperative for gaining invaluable insights into market challenges, as is collaboration with the Chief Human Resources Officer for robust succession planning and training of potential candidates.By taking these areas into consideration, CFOs can help lead their organizations and deliver better performance, positioning themselves for success in the future. 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.

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.