How risk managers can survive a ‘perfect storm’

As Winston Churchill once said: “If you are going through hell, keep going.”

This is an extraordinary time for risk management professionals. In 2008, when the global financial crisis unfolded, risk managers found themselves trying to counter the biggest financial shock since the Great Depression of the 1930s. Today, the world is facing a greater challenge — three global crises at the same time: the public health crisis, the geopolitical crisis, and the climate change crisis.

In 2020, the world was struck by a pandemic on the largest scale since the Spanish Flu in 1918. According to the World Health Organization’s latest estimate, Covid has already claimed nearly 15mn lives globally and is still far from over.

For some countries, the worst may be yet to come. Recently, the centre of Covid has shifted from Europe to Asia. In March, Hong Kong had the highest Covid death rate in the world. Today, the Chinese mainland is fighting against the Omicron variant and 25mn people in Shanghai have been in strict lockdown for several weeks.

While these draconian measures have not fully halted the spread of the virus, the economic costs to the Chinese economy are already overwhelming. For China, 2022 is likely to be the most difficult year since the pandemic began. It is likely to have a profound knock-on effect on the global economy and bring more disruption to the global supply chain.

The landscape of geopolitical risk dramatically changed on the day Vladimir Putin started his latest invasion of Ukraine. Europe is seeing a full-scale conflict in which two national armies are clashing on the ground, at sea, and in the air. Yet, by its nature, this is more than a regional war between two neighbouring countries. It is a war between two different worlds: the authoritarian and the democratic.

The war in Ukraine should be a wake-up call for western politicians, policymakers, and business leaders. Putin’s hybrid war against western democracy will stop only when his regime collapses. Until then, western democracies will have to deal with the humanitarian crisis in Ukraine and the risk of further military escalation and cyber warfare, as well as with disruptions to commodity markets, supply chains and international trade.

The world is also facing an existential crisis: global climate change. The UN’s Inter-Governmental Panel on Climate Change has recently concluded that the effects of human activities on climate to date are irreversible. We still have a chance to avoid a disaster, provided action is taken immediately. But this window is getting smaller with every day that passes.

So, today, financial institutions must react to three seemingly unrelated global crises simultaneously: a public health crisis which, on average, occurs only once every 100 years; a major geopolitical crisis which has not happened in a generation; and a global climate crisis which has no precedent in human history at all.

It is what we might call a “perfect storm”.

How can risk management professionals mitigate this toxic mix? There are three areas that managers should focus on to ensure a robust response.

Dealing with uncertainty
The dangers these crises have created are unprecedented. In this situation, reliable forecasting to inform management actions is hardly possible. Instead, risk managers need to use the most advanced methods of scenario analysis and stress testing to study potential outcomes and prepare a range of credible contingency plans to counter the possible implications of these crises.

Assessing indirect impact
Unlike the global financial crisis, none of these latest crises has a fundamentally financial nature. Most of the repercussions on financial services are second-order or even third-order effects. But most conventional risk management tools and models have been built to assess direct impacts. Now, risk managers should focus on enhancing their tools to measure and manage the second-order effects — for example, credit, reputational and compliance risks — triggered by these crises.

Addressing risk amplification
These three crises show a high level of interplay which amplifies the severity of each — for example, the disruption of global supply chains due to Covid and war in Ukraine. This creates the conditions for a tail-risk event that could explode when several factors greatly amplify each other. So it is vital for risk managers to strengthen operational resilience and crisis management frameworks and combine them with smart diversification and hedging.

Any crisis always brings new opportunities. Some 14 years ago, risk managers learned tough lessons on how to navigate extreme global financial shocks. Dealing with today’s toxic mix of events, industry leaders have the chance to bring their management frameworks to a new level — and it is a chance that they will have to take if they are to mitigate the tail risks of what appears to be a perfect storm.

Dr Evgueni Ivantsov is chair of the European Risk Management Council