The Volkswagen emissions scandal emphasises the importance of putting aside a contingency fund
The Volkswagen emissions manipulation scandal is being called the car industry's LIBOR moment – when a number of banks systemically manipulated interest rates.
It has also been likened to BP's Gulf of Mexico oil spill, as there are environmental implications.
Both the Gulf of Mexico and LIBOR cost the balance sheets of the companies involved billions of pounds, and this is likely to be the case with VW.
VW software was deliberately coded so vehicles would know if a test was being undertaken – most simply if the car was up on rollers in a lab rather than out on the road. The engine management system was programmed to drastically reduce emissions. The reduction can only work temporarily, but it’s enough for the test cycle.
The financial implications for VW are so great that there are now very real concerns that the scandal may put a dent in the German economy.
As with LIBOR, rigging was involved over an extended period. In August 2015, nine banks paid a total of $US9bn to investors in the US over claims they rigged foreign exchange markets, and their lawyers hope to launch similar lawsuits in London. This is in addition to billions of dollars already paid in fines.
The German carmaker, the world’s biggest, has admitted to US regulators that 11 million trucks and cars were fitted with software that cheated emissions tests. As well as a US regulatory penalty of $18bn, the company faces multi-billion-pound class-action lawsuits from customers and possibly shareholders.
In fact, the potential for VW's financial disaster could ultimately come from relentless and costly class actions that are likely to drain more cash than regulatory fines.
The scandal has already wiped more than €30bn off VW’s stock market value in just one week – one-third of its value.
It is clear that VW will need a large contingency fund (also known as a reserve fund) set aside to handle these unexpected spending pressures outside of the usual operating budget.
Contingency funds are also referred to as emergency funds, since the unexpected spending pressure commonly comes in the form of emergencies like disasters, health problems, and so on.
VW has confirmed it has set aside €6.5bn in a contingency fund to cover the financial fallout that will include fines and recalls – but history shows this will probably fall well short of the mark.
In the litigation-hungry US market, investors in VW will be itching to recover some of the fall in value the stock has suffered when the scandal broke. The US Environmental Protection Agency (EPA) can fine VW up to $37,500 for each individual vehicle that fails a clean air test. Almost half a million cars have been sold in the US since 2008 that require testing.
Germany’s Federal Motor Transport Authority has given VW until 7 October to come up with a detailed timetable for when all of its diesel vehicles will comply with emissions standards, according to German tabloid Bild am Sonntag. If the carmaker misses the deadline, it will be banned from selling those cars.
Brand damage will play into the ultimate cost but, at this stage, it is near impossible to assess; the ultimate cost of the scandal to VW will depend on how many countries the deceit extends. Already, Switzerland has banned diesel VWs and it was announced on 30 September that nearly 1.2 million VW vehicles sold in the UK were fitted with the software.
VW will not only need billions of dollars in a contingency fund, but they will also have to implement a contingency plan.
A contingency plan is defined simply as a plan devised for a specific situation when things could go wrong. It can be used for any situation but is most often used in business and by governments.
Businesses need to have contingency plans for all aspects of it operations, from marketing to financial strategy. Contingency plans need to be in place in case of decreased market share, planned expansions, and even recessions.
VW will have to manage the biggest car recall in history and a massive dent to its brand and consumer trust. Time will reveal just what VW executives have in the way of a plan.
Already the company has moved to try to restore some semblance of trust by confirming that three top executives would be fired and that the head of its sports car brand Porsche would become the new VW chief executive.
VW’s brand chief Herbert Diess has said the company is working on a technical upgrade for affected cars.
These developments are just the beginning of the implementation of its contingency plan, however.