Black swan events are unpredictable and have a severe impact on economies. Their effects on businesses can be devastating, so treasurers need to do all they can to limit the risks.
But how can finance managers prepare for the unforeseeable? Well, in this article, we’re exploring some of the ways treasurers can manage black swan risk, build a strategy and shield their companies from the potential consequences.
If you’re unfamiliar with the term ‘black swan’ you can find all you need to know, here: What is a black swan event? Definition and examples.
Black swan risk management
Managing black swan risk is a challenge for many reasons. But there are actions finance managers can take.
First and foremost, treasurers need to be aware that black swan events can happen. And they do, in different shapes and sizes.
However, crucially, they must not try to predict specific black swan events. This is because black swans are highly unpredictable with nothing in the past suggesting they’re about to happen.
Therefore, by focusing too intensely on events that have happened, they risk leaving themselves exposed to those that haven’t.
Let’s take the Covid-19 pandemic (which has been described as both a black swan and a grey swan event) as an example.
The ripple effects of the pandemic had catastrophic impacts on global supply chains. As a result, many businesses suffered huge cash flow issues, stunting growth.
In response, these affected companies may have piled significant resources into defending against future pandemics.
But while this offers protection in some areas, it increases vulnerability in others. For instance, a business focused on pandemics may be caught out if a war were to start, such as the Russia-Ukraine black swan.
With that in mind, let’s look at some of the elements treasurers need to consider when managing black swan risk.
Expand your black swan description
Treasurers need to think about widening their description of black swan events. The examples above are extreme, famous cases. But black swans appear in a variety of ways.
A particularly important area is how a business operates. When dramatic changes occur, businesses can face seismic shifts in the way they operate.
For instance, Switzerland used to be seen as a tax haven for the wealthy due to its low taxes and banking secrecy laws. But, in 2007, a major investigation found UBS – Switzerland’s largest bank – guilty of helping its clients evade taxes.
UBS was fined $780 million and forced to turn over 250 clients to avoid criminal indictment by the US government.
Consequently, the Foreign Account Tax Compliance Act (FATCA) came into effect in the US. This required individuals and institutions to communicate their offshore financial accounts and assets.
As a result, international banks and individuals completely reshaped the way they manage their assets.
Nothing is set in stone
One of the biggest black swan challenges is the lack of historical data to forecast future incidents. Mainly because these events have never happened before.
So, to effectively manage black swan risk, treasurers must continuously question and evaluate their current operations and strategy.
Currently, many industries are experiencing disruptive transformations. In financial services, for example, the rapid rise of FinTech companies is breaking the mould of traditional banking.
Traditional banks rely on hooking customers into an entire ecosystem of services and products; whereas FinTechs target specific problems and build trust with customers.
In the modern landscape, a traditional bank may be seen as a jack of all trades with FinTech’s being the master of one.
This kind of disruption to a set system can entirely reshape the way organisations see their business.
It is therefore essential for finance managers to watch trends inside and outside of their businesses and industries.
Through this, they can learn from others’ experiences and provide the foundations needed to shield against a variety of potential events.
The impact of emerging risks and controls
The risk management function must be active in identifying, monitoring and managing threats. It can do this through specific processes which run continuously – not on an annual basis.
Additionally, a business’s controls must be evaluated and refined regularly. Finance managers should consider emerging trends, market projections and the risk attitude of their business.
These are particularly applicable to large organisations. Why? Because big businesses face intense regulations, demanding heaps of controls to keep them sheltered from crisis.
However, black swan teachings suggest that these kinds of controls have the inverse effect. Mainly, this is due to too many controls making risk managers rigid, falsely believing they are shielded from harm.
Treasurers set in their ways lose a sense of agility as they become unable to react to catastrophic events. In turn, companies – and the markets they operate in – become more fragile.
Building a black swan strategy
We’ve stressed enough times that black swans are almost impossible to predict. And attempting to predict them can do more harm than good.
So when it comes to building a black swan strategy, treasures need to use tools and methods that test their businesses’ resilience. Not crystal balls that predict the future.
A tool all finance managers must use in their black swan strategy is data. As technology advances, data is becoming more prevalent, easier to access and essential for business function.
Through a data-driven approach to risk, treasurers become more agile with a better ability to react to uncertainty.
In their strategy, treasurers should think about using systems that feature artificial intelligence (AI), predictive analysis (PA) and statistical machine learning (SML).
AI, PA and SML can help them generate ‘what-if’ situations to test how their business would perform under stress.
Let’s say a black swan event hits and a company’s cash flow feels the full force. The what-if scenario – created with help from AI, PA and SML – provides running assessments of the business’s liquidity and other crucial metrics.
The results of the assessments show the business’s likelihood of making it through the fallout in one piece.
We’ve seen corporate treasurers adopt many different measures to mitigate black swan risk.
For instance, after the financial crisis of 2008, Deutsche Post DHL (one of the world’s largest courier companies) set up a syndicated loan facility to increase financial stability.
This meant the company was guaranteed access to credit in the wake of catastrophic events.
By combining intuition with high-calibrated measuring tools, treasurers can create strategies that limit the effects of black swan risk.
Protect against black swan risk
There are many areas of a business that can be affected by black swans. And many methods that can limit the risks.
For businesses that make international payments, an accomplished foreign exchange (FX) strategy can help mitigate the dangers of unpredictable events and their impact on currency markets.
At Privalgo, we help businesses create bespoke FX strategies through a range of financial solutions and expert guidance.
To find out what we can do for your business, request a callback from a Privalgo Foreign Exchange Specialist by filling in the form below.