Coined by former Wall Street trader Nassim Nicholas Taleb, the term ‘black swan event’ is used to describe events that have three distinct characteristics: they come with severe and widespread consequences, and are difficult to predict, although they may also be rationalised after the event. While opinions may vary as to what constitutes a black swan event, the term has been applied to everything from the dot-com crash and the 2008 financial crisis to Brexit, the election of Donald Trump and the arrival of COVID-19.
In 2022, black swan events have arguably included the Russian invasion of Ukraine – an event that has resulted in severe consequences both to financial markets and to the world economy, contributing to soaring inflation and disrupting the supply of key commodities. More recently, the label has also been applied to the collapse of crypto exchange FTX last month, which is continuing to have a severe impact on cryptocurrency markets.
“It’s been a very interesting year, and I think one of the reasons is the black swan events we’ve seen – in other words, events that have happened beyond the normal risk tolerance that treasurers perhaps use to manage their risks,” comments David Stebbings, Head of Treasury Advisory at PwC. “These events seem to be becoming more regular. So how does a treasurer take that into account when managing risk?”
As Stebbings explains, major risk events in the last year have included rising commodity prices particularly earlier in the year, and the LDI pensions turmoil resulting from the rapid risk in UK interest rates in the early autumn. These, he explains, prompted margin calls on hedging positions that have seriously affected liquidity in a short period of time – “and all of these events were someway beyond the limits of the 95% or 99% confidence of the usual models.”
As such, Stebbings highlights the importance of stress testing as a means of better preparing for future black swan events. “This might mean stress testing additional extreme scenarios around interest rates or FX movements, so that if an event happens, you have a better view as to where your limits are.” In practice, however, Stebbings argues that not enough treasurers are approaching stress testing in a comprehensive way.
“A lot of unexpected things have happened in the last few years, and when we look forward, the crystal ball is fuzzier than it’s ever been,” adds Peter Cunningham, Managing Director Head of Corporate, Commercial and Public Sector Sales & Marketing, EMEA at Citi. “If you’re a treasurer, it’s impossible to forecast what the future will look like – but the more optionality they can have in their operating models, the better.”
As Cunningham explains, this optionality includes not only activities such as FX risk management and hedging, but a host of other areas of treasury, such as having the right technology in place and working with the right number of banks to achieve the necessary level of flexibility.
“We are definitely seeing our clients looking at operational resilience as a topic for themselves,” he adds. “It’s hard, because you’re trying to pre-empt something that you don’t know will happen. As the risk management experts within the firm, treasury is being tasked with this – not just for treasury, but enterprise-wide.”