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The CFO – a moral rudder in the perfect storm by Eva Kingston, Felix Lopez and Joshua Wimberley

Key Takeaways: G  iven the activist role of the Federal Reserve during the crisis – particularly in opening the Fed window to the investment banks and their, in turn, opening the books to examiners and regulators — Goldman Sachs and Morgan Stanley were already on the road to greater regulation and implementation of Basel II capital adequacy rules prior to becoming bank holding companies. But while increased regulation will require additional disclosures regarding a firm’s inventory of complex financial products, there will also be an opportunity for financial institutions to partner with the regulators to help shape regulatory policy.


n the wake of the stresses on the financial markets following the Bear Stearns debacle, the subprime meltdown, the ongoing credit crunch and the rapidly changing regulatory landscape, financial

services organizations in the United States and abroad are being severely tested. These events, coupled with the bankruptcy of Lehman Brothers, the intervention by the Federal Reserve and the Treasury Department in rescuing AIG and mortgage giants Fannie Mae and Freddie Mac, along with the sale of Merrill Lynch and Wachovia have been referred to by some as “the perfect storm.” And they have raised troubling questions regarding some long-held tenets in economics, finance and deregulation.

Key Takeaways (cont.): E  ven as risk management and increased regulator oversight place greater demands on CFOs, the office of finance continues to evolve beyond its traditional back-office role to front-office business partner. T  he challenge for the CFO is to be a reliable business partner, while remaining independent: to act as the moral rudder to the firm. T  he issue of leadership in a CFO has never been more crucial. Companies and their boards are looking beyond technical competency and prowess, but are looking for individuals who can handle the unknowns that lie around the corner.

Historic changes have already taken place. The US government has passed the $700 billion mortgage asset bailout of the banks. And the sale of Merrill Lynch to Bank of America and the subsequent announcements by Goldman Sachs and Morgan Stanley to transform themselves into bank holding companies and to accept increased government regulation and oversight by the Federal Reserve marks the end of investment banking as we know it. One of the principal regulatory innovations from the New Deal—the separation of investment banking from commercial banking—has been laid to rest. A “new” New Deal is taking shape before our eyes: this new contract between government, the financial sector and the public will entail enhanced oversight by the Fed and a restructuring of the Securities and Exchange Commission, which proved itself woefully inadequate and unprepared to regulate the plethora of exotic financial derivative instruments invented by the investment banking sector. However, the shaky reaction of the markets to these changes suggests that the hurricane has not passed. Already investors are looking for breaches in other levees, including the credit derivatives swap market and even more exotic and opaque markets. Hedge funds and private equity groups, the two other drivers of the financial markets, remain intact—for the moment. But it is unlikely that they will emerge intact and unfettered. As the two remaining feet in Wall Street’s three-legged stool, an edifice based on leverage and transferring risk, their future looks shaky at best. As we go to press, we are seeing events unfold daily that are unprecedented. And, while it is still too early to hazard a guess at what the lasting ramifications will be to CFO and finance departments at financial services firms, the broad outlines are beginning to emerge. Chief among them are likely to be: the increased role of the CFO as point person in managing government and regulatory agencies; the focus on liquidity, Tier-1 ratios and balance sheet capital; the increasing emphasis of the CFO’s role on overseeing risk, regulatory compliance and finance; the challenge


to the CFO of maintaining the role as business partner of the operations and enabling the company to take advantage of strategic opportunities at a moment when the industry is growing risk-averse; the focus on the CFO as the moral rudder and compass of the organization; and the potential danger that finance organizations may not be able to attract star talent in a period in which the role is seen as overly bureaucratic and less entrepreneurial.

Increased Regulation: The CFO, the Point Person to Regulators

Given the activist role of the Federal Reserve during the crisis – particularly in opening the Fed window to the investment banks and their, in turn, opening the books to examiners and regulators — Goldman Sachs and Morgan Stanley were already on the road to greater regulation and implementation of Basel II capital adequacy rules prior to becoming bank holding companies. But while increased regulation will require additional disclosures regarding a firm’s inventory of complex financial products, there will also be an opportunity for financial institutions to partner with the regulators to help shape regulatory policy. Risk management is clearly the watchword, both among regulators and those they oversee. Leverage will be paramount going forward, believes a senior audit partner at a Big Four firm, as well as the issue of liquidity and Tier-1 capital ratios. At the same time, however, he suspects that the Fed along with other central banks may reexamine their own risk models and assumptions, especially in light of the discussion that Basel II is reflective of the same qualitative risk models that led to the crisis. The issue of risk as it relates to the points in the economic cycle is likely to be looked at by central banks as they focus on financial stability as well as inflation rates. The Fed will be embedding itself in the regulation of the brokerdealers, which will have a direct impact on the industry, says Richard M. Speziale, managing director at Citigroup. But while the SEC has generally been focused over the years on capital, capital alone will not enable a firm to stay in business, he says, referring to the case of Bear Stearns and Lehman Brothers. “What the Fed and the SEC


should both focus on is risk management and liquidity,” says Mr. Speziale. “Capital is good to have if you have to liquidate your firm, because you can pay off your clients, etcetera. But it doesn’t ensure that the firm will remain viable.” He emphasizes that his firm, along with others, will be doing more testing of stress scenarios. What happened leading up to the crisis was that all the firms, Citigroup included, put too much of one type of asset on the balance sheets, says Mr. Speziale. “Any financial firm that puts on that much of one asset class—obviously there are risks.”

CFO: At the Nexus of Finance, Risk and Compliance

CFOs, increasingly, will have the responsibility of looking deeper and understanding the securities on their balance sheets. Uppermost in the minds of most will be how to prevent a “Bear Stearns” or a “Lehman” from happening at their firm. Capital and liquidity is certainly paramount in the CFO’s strategy. But there is more. “CFOs are already involved in valuation at a high level, but you’re going to see them getting a much better understanding of how their companies are valuing complex products, whether it is derivatives, CDOs or other complex financial products,” says the Big Four audit partner. “They’re going to play a much more active role in the valuation and management of those types of products and how they can impact the funding and financials.” One effect is certain to be a reorganization of the lines of responsibility. Firms already are examining the potential for the CFO to take on a more active role in overseeing risk. At those firms hit hardest by the credit crunch, such as Merrill Lynch and Citigroup, there was a silo approach to risk management, with little or no communication among risk, finance and operations, while at the ones which successfully navigated the storm, such as JPMorgan Chase, Deutsche Bank and Goldman Sachs, the CFO was deeply involved in monitoring and managing risk across the organization. Nowhere was this more the case than with Goldman Sachs—the one broker-dealer to successfully navigate the credit storm. There, risk in all its flavors—market, operational, credit, liquidity, as well


as controllership—all report to Goldman CFO David Viniar. Other banks and broker-dealers are taking up Goldman Sachs’ approach in establishing new management structures and are having Risk report directly to the CFO, or else, as in the case of Citigroup, are making the chief risk officer a peer of the CFO, while at the same time making certain that the CFO is deeply engaged in monitoring risk. Whichever approach the firm decides to take, it is essential to empower the CFO and/or CRO in confronting the business side of the organization. Key to managing risk, Citigroup’s Mr. Speziale says, is approaching and analyzing his businesses and clients from the perspective of returns and margins. Citigroup, he says, chased revenue growth and operating leverage over the years, rather than returns. “I’m looking at the assets we deploy, at our cost of capital, and at what our returns are after that, rather than just revenue growth,” says Mr. Speziale. “It can’t just be about revenue growth. It has to be about profitability and about the returns after the cost of capital.” This does not mean the CFO must turn himself into a quant and understand all the complexities of derivatives or other synthetic securities. “But if 30% of my balance sheet is concentrated in one asset class, then I need to start asking questions,” says Mr. Speziale. “If I have an asset class that’s growing and growing just because it happens to be producing revenue at that moment in time, then I have to be aware of that. With anything that’s generating lots of revenues, there’s probably a great deal of risk in that.”

Europe and Beyond

While U.S. banks and broker-dealers have been at the epicenter of the credit crisis, the effects of the turmoil are not relegated to the U.S, alone. Many of the same financial instruments that resulted in massive write-downs at U.S. firms found their way onto the balance sheets of many European banks, and the phenomenon of overheating real estate markets can be said to be global. And cheap money made many businesses and strategies look much better than they actually were.


Banks in Europe, like their counterparts in the U.S., have drawn some serious and sobering lessons about managing risk from the excesses of the past decade, notes Richard Meddings, Group Finance Director for Standard Chartered PLC. “There was a debate that boards and managers and regulators all had, which was that risk had become more dispersed as we had created all these credit and credit derivative instruments. And then of course, we realized that rather than dispersing the risk, we had actually concentrated it back into the bank sector,” says Mr. Meddings. “Fundamentally, people lost the understanding of the truly important foundation of the banking sector, which is essentially liquidity.” Standard Chartered managed to steer clear of many of the financial shoals, remarks Mr. Meddings, as a result of not being concentrated in any one market or business and because it runs on the basis where it has no single, sizable home market. The bank also requires all of its business and regions where it operates to “self-stand” and manage their own liquidity without the parent group intervening. “When you add that altogether, the liquidity position of the parent is all the more stronger,” he says. “But if you’ve been running a bank where you have one big home market and a number of smaller satellites, then you might not have had the same outcome as we did.” The role of the CFO has if anything become more demanding and important than any other role, he believes. “The outcomes are calculable and specific, and therefore, do not lend themselves to generalized answers. It requires diligence and hard work to get on top of the numbers. You have to constantly think about them and about what they mean and tell you in terms of signals about the business and how you should deal with it,” says Mr. Meddings. It calls for integrity, technical rigor, the ability to surround oneself with good talent and delegate and empower, and finally to be realistic in terms of budgets and forecasts—to strike the balance between aspirations and realism. He adds: “The job is to be the soul and conscience of the organization, to remain anxious, to remain constantly inquisitive.”


CFO’s Evolving Role

At the same time that risk management and increased regulatory oversight place greater demands on the CFO, the finance function continues to evolve from its traditional back office role of accounting for receivables and assets into what is best described as a frontoffice business partner. CFOs are tied into every aspect of the organization and business, from technology to human resources to benefits. The office of finance is being asked to do things that they have never done before. “In many ways, as a CFO, I feel as if we have a bull’s-eye on our back,” says Joseph M. Ramos Jr., CFO of Seibert Financial Corp. The added responsibilities place constraints on the CFO from acting as a true business partner to the executive team and bringing the focus of finance to the strategic and operational issues that face the firm. In particular, the regulatory issues almost certain to arise out of the current crisis coupled with Sarbanes-Oxley compliance will leave the CFO and finance department with even less time to focus on the business overall. “I think the virtues of SOX are great, but practically speaking, it is very difficult and expensive to maintain and to be in compliance with,” says Mr. Ramos. And where it comes to the burdens of Section 404, management’s attesting to the effectiveness of internal controls over financial reporting, he adds: “404 is a lot of work whether you’re a small company or a big one.” He finds himself addressing regulatory and compliance issues rather than tracking the business and growing it. “I like growing and building a business, rather than simply making certain that my internal controls are in place.”

The Moral Rudder and Compass to the Organization

The CFO in the evolving financial services landscape has two important mandates: to be a good and reliable business partner who enables the firm to accomplish its goals and undertakings, while acting as the moral rudder and compass to the organization. It is a unique and peculiar position, one that contains its own inherent contradictions and tensions. Some would argue that the two mandates are irreconcilable and that in the desire to act as a business partner, the CFO will relegate his responsibility as moral compass to secondary importance; or conversely, the CFO will inhibit the firm’s growth as a result of excessive caution.


The key question for the CFO is: How does one remain closely engaged in the business to understand what is going on while at the same retaining the influence and independence with the organization to sound the alert to senior management as to the potential risks of an undertaking or business practice? “One lesson that comes out of the current credit crisis is the need for better strategic risk management on the part of the banks and investment banks. This is an issue that goes beyond the question of credit risk. The decisions by many financial institutions to get into bad financial product areas or else to make an acquisition at the top of the market, disregarding where we are in the business and risk cycle, were poor strategic decisions,” says Robert Qutub, president of Banc of America Securities Holding Co. “It highlights the need for convergence of the CFO and CRO in the decision-making process so that they are in the position to give good strategic advice and to ask the simple question: What is the business?” The tensions, to be sure, are real but not irreconcilable. In being a good business partner and enabling the businesses to grow, the CFO gains greater credibility and stature for the times when his responsibility as the moral compass of the firm requires that he rein in risky undertakings. The challenge is to be a reliable business partner, while at the same time remaining independent, to act as the moral rudder to the enterprise, deciding whether a particular behavior or conduct is an issue to the long-term viability and health of the enterprise It is easier to fulfill one’s role as the moral rudder during the sober periods that inevitably follow any crisis. That is especially the case today when the losses, write-downs, layoffs and evaporation of wealth are fresh in mind. The real challenge comes when the financial markets and system returns to a more normal period. Human beings have short memories. “Some firms see the CFO as a business partner. Some see the role as being the protector of the company. And some firms treat the CFO as someone who just ensures the financial integrity of the firm but who doesn’t really have a voice. Hopefully, the better firms will have learned from this experience,” says Citigroup’s Mr. Speziale. “At the really good firms, the CFO has that voice at the table.”


CFO: Leader, Manager and Evaluator of Talent

Leadership in a CFO is crucial. No single individual, however, can tackle all the complexities facing an organization. The CFO is only as good as the broader finance team around him. But conversely, the team is a reflection of the qualities of its leadership. So what are some of the traits and core competencies the CFO must bring to the job so as to stay ahead of the curve? Our conclusion, which we have arrived at through evaluations using our proprietary behavioral assessment and developmental tools, is that the key to a CFO successfully staying ahead of the curve is the following: to surround him/herself with the right people, to be a good, strong manager of people, to be a good evaluator of talent and to provide the necessary leadership at the top for the talented people on those next tiers. More than anything else, CFOs must provide leadership, be able to evaluate talent and make certain that the right talent is in place. In particular, they must ensure that succession plans are in place in the event that a key figure in the organization, such as the head of risk or of regulatory compliance, leaves the firm. But even as the current credit crisis and the accounting and auditing scandals earlier in the decade have clearly demonstrated the need for strong finance talent, the remedies of greater regulation and paperwork have made it more difficult to attract that talent to the office of finance. The implementation of Sarbanes-Oxley and 404 have already placed great demands on the CFO and finance, and the new regulations that are expected from the SEC and the Federal Reserve will make it that much more difficult to bring in new talent, especially given the attractive alternative that exist in private equity or hedge funds, where the CFO and his team do not have to deal with the more onerous aspects of regulation and can focus instead on strategy, analysis and on being a partner to the business. However in our experience, attracting talent is only the first step for CFOs. Developing and grooming that talent will become more important going forward. “This is a tough environment in which to learn on the job,” says Siebert’s Mr. Ramos, who was only 34 years old when he became CFO at brokerage Cantor Fitzgerald. Yet getting that experience is all the more crucial so as to be able to make the right choices. “It’s important to work for someone who will bring you in and teach you.”


CFO: Looking Ahead Evolving Role of the CFO Former Focus of CFO: Fiduciary responsibilities Internal and External financial reporting Regulatory compliance Governance controls Back office role Business process efficiencies Automating business processes and achieving greater efficiencies Funding issues

Current Focus of CFO: Moral rudder and ultimate protector of the organization Risk management Greater regulatory oversight by the Federal Reserve and the SEC Focus on liquidity, funding and credit risks and stress testing Increased focus on derivative securities and balance sheet risk Strategic business partner to the operating units Manager and evaluator of talent Master of detail, yet possessing vision Increased engagement with the board Leadership

As the role of the CFO continues to evolve, we are seeing a new type of finance executive emerge in the financial services and investment banking industry. The CFO has become more important than ever given the finance and credit issues that have arisen during the current crisis. The CFO must become more deeply engaged than ever in managing risk at the organization, digging deeper into the


balance sheet to understand the underlying risks. Given the growing regulatory demands, the CFO must be a master of detail, while retaining a broader vision. They must attract and cultivate new talent within the finance department. Finally, they must be able to balance their role as strategic business partner with their position as the moral rudder of the firm. Financial services firms are operating in an economic, regulatory and business environment that is undergoing climactic changes. The issue of leadership in a CFO has never been more crucial. Our conversations with boards and senior management reflect this concern. Companies are looking beyond mere technical competency and prowess. Instead, firms are looking for those individuals who can handle the unknowns that lie just around the bend, who bring not only experience but also the abilities and instincts to see around corners. Most importantly, the CFO must have the backbone to stand up to the businesses and ask tough questions. Increasingly, our discussions with boards, senior management, shareholders and various stakeholders have focused on the topic of leadership and those intangible qualities that make for true leaders and problem solvers. To be sure, the CFO is not alone in this work. In this current environment, every financial services firm and bank is looking hard at its internal culture, cultivating a strong performance-based culture with a strong values-based culture and understanding that the two cannot be mutually exclusive if the firm is to thrive. It is in that context that the role of the CFO as the conscience and ultimate protector of the organization has never been more crucial.


Eva Kingston is a Client Partner in Korn/Ferry’s Global Financial Market, based in London.

Felix Lopez is a Client Partner in Korn/Ferry’s Global Financial Market, based in New York

Joshua Wimberley is a Senior Client Partner in Korn/Ferry’s Global Financial Market and Financial Officers Practice, based in Atlanta.

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The CFO – A Moral Rudder In The Perfect Storm  

The CFO – A Moral Rudder In The Perfect Storm