The war in Ukraine: Four areas of focus for finance and risk

Russia and Ukraine are vital world suppliers

Both Russia and Ukraine are important suppliers of commodities and raw materials, many of which have seen sharp price increases since the war began.¹ They’re both significant exporters of agricultural products that are critical for food and beverage companies.²

Ukraine is a key source of raw materials for the semiconductor industry, with about half of the world’s neon gas supply and 40% of its krypton gas supply.³ Semiconductor chips are critical inputs into numerous products and services, including household appliances, smartphones, laptops, printers, gaming consoles, PCs, automobiles, airplanes, and medical devices, among others.⁴

Russia is an energy powerhouse that ranks as the world’s third largest oil producer and top gas exporter.⁵ Oil and gas prices have skyrocketed due to concerns about Russian supply. While they’ve dipped since their peak in March 2022, they’re still high compared to historical levels.⁶

What this means for profitability

The impact on profitability will vary across industries and markets. Naturally, it depends on the importance of energy, raw materials and agricultural commodities to cost structure.

Sectors like automotive, industrials and food could take a significant hit, particularly in Europe, where reliance on Russian oil and gas is highest. The pressure on prices and wages from these supply shocks will have ripple effects across other industries globally.⁷

Inflation

The current shock has drawn comparisons with the stagflationary shocks of the 1970s.⁸ However, the impact of oil price surges has become less severe over time and consensus estimates don’t see inflation reaching double-digit levels in the next year in the United Kingdom, France and Germany (Figure 1).

Figure 1: Energy price shocks and inflation in Europe

Consumer confidence in Europe has dropped, reaching its lowest level since April 2020 in April.⁹ In the United States, consumer sentiment was already on a downward path and hit its lowest level since August 2011 in early May.¹⁰ The erosion of consumer confidence is of particular concern for consumer goods and retail, as it may decrease spending.

GDP

The conflict in Ukraine is also likely to drag global gross domestic product (GDP) growth:

• The Organisation for Economic Co-operation and Development (OECD) estimates global economic growth to be more than one percentage point lower this year than projected before the conflict.¹¹
• The United Nations Conference on Trade and Development (UNCTAD) has downgraded its global economic growth projection for 2022 by one percentage point.¹²

The question of recession

The consensus among international institutions and investment banks is that we’ll avoid a recession in 2022.¹³ However, long-term headwinds are mounting. Monetary policy is expected to tighten aggressively in the US. This has some analysts pointing to the risk of a recession next year.¹⁴

Against this backdrop of uncertainty, chief financial officers (CFOs) and chief risk officers (CROs) should assess vulnerabilities and cost reduction while pivoting to new sources of growth.

Four areas of focus

In unpredictable situations, focus is essential. While each organization has its own priorities, we recommend paying attention to these areas in the short term:

1. Expand and accelerate scenario planning.
2. Evaluate and mitigate operational risks.
3. Put effective cost-control measures in place.
4. Assess and implement divestment decisions.

1. Scenario planning

Navigating uncertainty without data is like navigating a storm without radar. Insights help you to act with speed and agility.

Work with stakeholders to build a rapid scenario modelling capability. The shorthand:

1. Create a cross-functional team to help ensure your models include relevant internal and external factors.
2. Use intelligent automation and machine learning to speed up the planning and decision cycle.
3. Make sure your scenarios span the entire enterprise, bringing customer demand, financials, workforce planning and supply planning into a single model.

Areas to model will vary by industry and market but may include:

• Operational impacts, such as closing operations in affected areas
• Changes in customer demand due to higher prices or lower consumer confidence
• Evolution of energy, raw materials and other input prices
• Supply chain implications
• Workforce planning, including talent shortages and decisions to work remotely or in-person

Your goal is to run a series of scenarios that continually reflect changing circumstances and assumptions.

2. Operational risk

The crisis in Ukraine affects a company’s risk profile along five major dimensions. As an integral part of decision-making, screening and strategy planning, the CRO and their team should work with finance to review exposure across all of them.

Consider setting up controls for new threats based on analysis of cyber intelligence.

3. Cost reduction

If you have major operations in Russia and Ukraine, cutting costs could be a matter of survival.

Scan your value chain

The crisis primarily affects business outlook through inflationary pressures. As such, keep a close eye on cost structure. Consider both direct exposure to higher energy and raw materials costs as well as their indirect exposure to inflation along the value chain.

Take inventory of general costs

Items for discussion:

• reducing capacity
• reducing, deferring or spreading discretionary expenditure over a longer period
• smarter procurement
• renting rather than owning assets
• looking for outsourcing opportunities

Keep in mind, the broader goal is to reset your cost baseline for the emerging new reality.

Usually, sanctions are imposed faster than they’re removed. As a result, cross-border trade may continue to be costly. The crisis has also recentered focus around fossil fuels, accelerating the trend toward renewable energy. Talent was scarce before the crisis and it is likely to remain so after. For this reason, it’s important for cost-cutting programs to allow for the support of strategic assets.

4. Divestment decisions

Many businesses have already made the decision regarding whether to suspend or discontinue operations in Russia. Recently, some companies that initially suspended operations have decided to permanently leave the country.¹⁸

To stay or go?

How you make and carry out these decisions may vary from business to business. The complexity, size and nature of your financial commitment in the market are all important factors. Companies in asset-light sectors may find it easier than those with challenges such as:

• Running large inventories
• Having a physical presence with stores and plants
• Operating in franchises or in partnership with local state-owned enterprises

For them, the path from decision to exit is long and includes the risk of asset appropriation, among others. Given geopolitical uncertainty, CFOs of asset-intensive companies might consider discontinuing operations while trying to hold onto their assets, waiting for better times ahead.

Common issues to consider

1. People: Figuring out how to support your people in Russia in the case of divestment is crucial. Pay special attention to their safety, well-being and employment needs.
2. Legal: Work with your counsel to evaluate proposed transactions against the sanctions and counter-sanctions in place. In light of how quickly things are evolving, consider refreshing these assessments regularly.
3. Capabilities: Will your withdrawal leave any gaps in your capabilities? If so, consider the adjustments and acquisitions you’ll have to make to fill them.

Eye on growth

For now, change may be the only constant. But finance and risk leaders have the ability to bring things into focus for their companies.

Centering the discussion around these four areas—planning, risk, costs and divestment—will help you ground your CEOs and leadership teams with the critical analysis and insights they need right now. In doing so, you’ll all be better positioned to assess vulnerabilities, take action to contain costs and stay on track for growth.

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