Risk Management

Black swan: expecting the unexpected

Published: Nov 2018
Black swn swimming in lake with the sun reflecting in the water

It happened ten years ago, but memories of Lehman Brothers’ collapse in September 2008 still strikes fear into the heart of corporate treasury. The paralysis in short-term liquidity markets and wider capital market dislocation made refinancing maturing corporate debt nigh on impossible. “Liquidity dried up across the whole financial market,” recalls Stephen Hogan, Vice President Regional Treasury Asia Pacific at Deutsche Post DHL Group, based in Singapore for the past 14 years.

DHL has since set up a syndicated loan facility that guarantees access to credit in times of crisis, and the global logistics group spreads maturing debt across multiple years, ensuring refinancing never all comes at once. “If you were trying to refinance after Lehman’s it didn’t matter who you were, you couldn’t. We now pay to have committed credit lines in place because that’s what you need in a crisis,” says Hogan.

High impact, low likelihood black swan events, often only explainable after they happen, are in fact surprisingly common. Lehman’s collapse, 9/11, Japan’s devasting 2011 earthquake and its impact on the Fukushima nuclear power plant, and Iceland’s volcanic ash cloud are just a few. Black swans are destructive, particularly if they catch a corporate with thin margins and high gearings, or at a weak moment in its history. The Lockerbie bombing was struggling PanAm’s deathblow; BP called the Deepwater Horizon tragedy in the Gulf of Mexico the greatest challenge in its 100-year history and “threatened its very existence”.”

Black swans are difficult to predict and therefore plan for – thinking the unthinkable is after all an oxymoron. Yet an operational crisis can quickly develop into a financial crisis and treasury’s role in preparing for the unexpected is both essential, and entirely possible.

Relationships built up over many years enabled us to mount the biggest corporate financial defence of all time.

Dev Sanyal, Executive Vice President and Group Chief of Staff, BP

First and foremost, treasury needs liquidity on hand. DHL measures how much liquidity it needs on standby in its syndicated facility by running stress testing scenarios. It’s a trade-off between the cost of the facility and the damage wrought without it, says Hogan. “You need to balance the cost with the need, and the problems that may occur if you can’t access it.” Other strategies to meet sudden and unexpected calls on liquidity could include liquidating bonds, says Socrates Coudounaris, Chairman of the Institute of Risk Management. He points treasury teams to the World Economic Forum’s annual Global Risks Report to identify which risks and consequences are most pertinent to the business.

For companies that find borrowing challenging or want to reduce the cost of drawing on credit facilities, alternative liquidity preparation could include mobilising cash from within the organisation. Treasury could transfer cash from a market that is generating excess cash to one that is short or look to supply chains to discount receivables and free up working capital that way. It requires a transparent view of cash levels and good data, says Victor Penna who heads Standard Chartered’s Europe and Americas cash management team. “Every crisis has the same result – liquidity dries up. A really good treasury makes sure there are different routes for funding the business, so if treasury is caught out in one area it can utilise the other.”

Strong bank relationships

There is nothing like a sudden liquidity call to test the mettle of banking relationships. High-touch, trusted banking partners who understand the business and the market it operates in are key to survival in a crisis. And banks which know the corporate best and have long provided the nuts and bolts of its day to day banking are most likely to answer urgent demands for credit.

Witness BP’s 86-day, high-stake battle to stem the flow of oil gushing out of the Deepwater Horizon well. Political pressure and negative press, coupled with a downgrade in the company’s credit rating, saw some banks fall away. Yet BP’s long-term core lenders held steady, sure in the knowledge that the company’s strong assets, credit profile and the contingencies in place, would prevent insolvency. “Relationships built up over many years enabled us to mount the biggest corporate financial defence of all time,” said BP’s Dev Sanyal, Executive Vice President and Group Chief of Staff speaking in 2012.

Indeed, black swans galvanize and fortify treasury’s banking relationships and can lead to opportunities for the banks that stay the course. A crisis can act as a catalyst for companies to have a fresh look at their capital structure or lead to decisions to sell off none-core assets, says Lance Kawaguchi, HSBC’s Global Head – Corporates. “The relationship can grow closer because treasury is engaging with banks even more,” he says.


Hedging is another vital tool, allowing treasury to prepare ahead by transferring credit, interest rate or currency risk to market counterparties. But just like assessing liquidity needs, it’s a question of judgement, bearing in mind interest rate, credit and currency markets start to price risk quickly as soon as the storm clouds appear.

Take Brexit as an example, says Andrew Lillywhite, Head of Treasury, Products and Distribution at Investec. He argues a 30-40% devaluation in sterling following a no-deal Brexit would qualify as a black swan today because it’s not priced into the market. It means UK corporates with exposure to a fall in sterling should make choices today whether it’s worth paying the price of transferring that risk to a bank, versus the potential cost to their business if the pound plunges. “The price of umbrellas is always highest when the storm is approaching,” says Lillywhite. “Treasurers need to be engaged with trusted relationships who understand their business and have an appetite to take risk off their hands,” he says.

Other strategies to offload risk could include diversifying suppliers or buying insurance so companies can pay for losses quickly, easing liquidity constraints and smoothing balance sheets. Insurance also protects against counterparty failures, but perhaps most importantly its purchase – or not – involves a thoughtful process which clarifies what the risk is, the scenarios where it could play out and the financial implications.

Try and break your organisation; then work backwards to see what you need to do to ensure it doesn’t break.

Socrates Coudounaris, Chairman, Institute of Risk Management

For treasurers who question if the right instrument exists to insure their specific risk, this process will flag the gaps, says Coudounaris.Brokers then advise companies what cover is available, and treasury can decide if it’s worth it. It was exactly this thought process that led some airlines to buy insurance cover for volcanic ash-related claims and others not to bother – until Iceland’s 2011 volcanic ash cloud proved its worth. “Once bitten twice shy; now they all do it,” says Coudounaris.

Moreover, the cost of premiums allows treasury to draw on an externalview of risk. Premiums reflect the market’s view of the health of the company’s balance sheet and its preparedness, just like home owners with burglar alarms pay smaller premiums. “A premium is a proxy for risk so if the premium is high, the question is: ‘why is that premium high?’ Think of it like a credit rating,” says Peter Johnson, Senior Vice President at Marsh Risk Consulting.

Stress test

Organisations with well-built and practiced crisis management programmes are best placed to navigate black swans, and reverse stress testing is an important tool for informing these forward thinking,well-planned scenarios. “Try and break your organisation; then work backwards to see what you need to do to ensure it doesn’t break,” says Coudounaris.

This could involve stress testing supply chains, particularly for concentration risk, so companies can identify alternative sources and know ahead what it would cost. These are just the type of strategies that would have helped Japanese auto firms better navigate the impact of the Thai floods in 2012 which revealed the fragility of international manufacturers’ supply chains. A deep dive into customer behaviour is also helpful for forecasting cash flows. “It reveals who pays on time and who pays late, from which treasury can deduce what proportion of revenue comes from late payers, and how many there are, all of which can have significant impacts on your forecasting,” suggests Mark O’Toole, Head of Sales and Marketing at Cashforce, a fintech platform for
treasurers. O’Toole also argues that the growing frequency of black swans means treasury should increasingly plan for the grey area between a white swan world of smooth corporate strategies, and the unpredictable devastation of a black swan event.

Yet unlike banks and insurance companies where regulation now forcesstress tests, the average corporate doesn’t have to comply with capital adequacy or solvency regulation. Although FTSE listed companies must meet governance codes in line with Financial Reporting Council, FRC,rules, filing corporate accounts and an audit from one of the ‘big four’doesn’t equate to stress testing. Nor is it something that can be easily done on an Excel spreadsheet, says Standard Chartered’s Penna.

Stress testing tends to be confined to sophisticated companies which have learnt hard lessons from their exposure to global markets and seen first-hand how risk bleeds from a plunging currency to a hike in interest rates. “It is not easy to run scenarios; it needs good tools and the firms that are able to do it have invested in the risk management systems that can run the models,” says Desiree Pires, Co-Head of UK Corporate Sales, Financial Markets at Standard Chartered. “That said, TMS tools and other software providers are making it more accessible. Perhaps the key part is winning over internal hearts and minds that it’s necessary.”

Board buy-in

Without regulation, successful crisis management needs to come from the board, which must also lead on instilling a risk management culture.Preparing for a cyber-attack is a good way to structure a whole company response to unpredictable risk, suggests Johnson. “Nowhere is the need for a multi-disciplinary response more apparent than in cyber risk,” he says, evoking a battlefield to describe how companies should respond. In-house cyber-security teams are the frontline, supported by a central risk function that has identified the risk and set out a
response. This is then backed by a board that asks the right questions and holds the risk function to account. Boards should also counsel outside opinions to ensure they aren’t marking their own homework,advises Investec’s Lillywhite. Risks diminish in our minds with stability and this allows us to ignore potential dangers: once they happen it is often too late to manage them, he says.

Companies with board buy-in can then relax. DHL doesn’t discuss black swans in everyday risk management. Nor is it a topic regularly fed up through treasury to the board, says Hogan. “Our risk management discussions focus on our reaction to events that have a bit of a likelihood of happening. We rarely discuss the unthinkable; we don’t really discuss black swans.”

Work remotely

Treasury also needs robust IT networks that ensure the ability to work remotely. This was crucial for DHL’s Japanese subsidiaries following the earthquake and tsunami, says Hogan. “We needed to be able to keep the business running locally, despite the impact on the country.” Remote payments also enabled DHL to pay staff and colleagues struggling in the aftermath. In fact, technology is so crucial to companies’ ability to survive the unexpected, treasury should only work with banks that are investing in new platforms and mobile, says HSBC’sKawaguchi who warns that “not all banks do”. More cygnet than swan, but unexpected and damaging none the less, Kawaguchi recalls an M&A transaction were the buyer was unable to get into their office to transfer funds and couldn’t send the money remotely either. “I remember sitting in a room with the client, waiting for funds to come in from another financial institution so we could finalise an acquisition. You
need that transfer to run smoothly whatever happens,” he says.

Companies that come through unprecedented crises emerge stronger, and many of the drivers of safety and risk management also drive value creation. For many companies it takes a sudden and unforeseen event for treasury to get its black swan fire drill in place. But it’s much better to prepare for the unexpected and think the unthinkable than get wise after the event.

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