Managing major market risks: How are you preparing for the Bond Notes?


By Thomas Sithole

Throughout my line of work in Enterprise Risk Management, I have come to appreciate that when it comes to risk, there are events that we can influence and others that no one can change. Both types of risks can be managed but as a risk manager, you need to understand that you can’t debate over things that you cannot influence. A case in point is the introduction of a ‘pseudo’ currency in Zimbabwe and how it will affect business. I have already put my thoughts on the record that I believe that this is a bad move, but since I can’t block the introduction of Bond Notes, I have quickly transitioned into developing solutions to ensure that businesses are able to weather the impending shocks.

High economic uncertainty is not something that is witnessed in Zimbabwe alone. We have recently witnessed an unprecedented Brexit referendum in the UK and from a risk management standpoint; I would like you to put yourself in the shoes of a Chief Risk Officer of say, a FTSE 100 company. How are you supposed to manage the ripple events that are going to stem from Brexit? The market’s reaction in the wake of the referendum was something of a slap on the wrist to the whole of Britain rebuking them for wanting to leave the EU. What will be the market’s ‘full’ reaction when the UK does initiate the so called article 50 and formally leave the EU? Scary thoughts indeed!

A couple of months ago, I asked myself how best could I help my clients better prepare for the introduction of Bond Notes. To find the answer, I had to take a step back and embrace the basic ethos of Enterprise Risk Management that calls for one to take a holistic – bird’s eye view of risk. While every risk manger’s toolbox is full of risk responses to common risks such as credit, liquidity, funding level risks, and so on, there is nothing in the toolbox to counter the effects of major market risks. This however seems to go against my assertion that every risk can be managed, since the average risk manager’s toolbox seems to have risk responses to only those risks that can influenced.

To digress a bit, but still on the topic of risks that we can’t influence; looking at earthquakes, it is clear that if a major quake were to occur in a densely populated area, it would cause major economic damage. However, if a similar quake were to occur in the middle of say, the Siberian desert, it would probably not even make it on to the 8 o’clock news. Earthquake risk management is not concerned with preventing earthquakes (a seemingly impossible feat), it is instead aimed at reducing the impact once an earthquake occurs. Come to think of it, people do not die because of earthquakes; they die because a roof, freeway overpass or an entire building falls on top of them due to the earthquake. The same line of thought needs to be applied to major market shocks. Companies do not collapse because of market risk per se; they collapse because of secondary risks that would have been triggered by that market shock.

Rather than try to influence the market risk (an impossible feat) we are better off managing the link between market risk and the rest of the risks that we are exposed to. Market risks can trigger a domino effect that can lead to detrimental credit risk, Exchange rate or Liquidity risk exposures. Market risk management then calls for ERM to go a step further from purely managing these credit, liquidity and forex risks, but also managing their link with the possible market shock. Visualizing the domino effect can be a simple, yet powerful framework to developing strategies to position your business to better withstand market shocks. How hard a domino falls depends on its distance from the domino in front of it, increasing that distance will lessen the impact of the market shock. How can you achieve this in your business? An even more effective action will be to re-position the domino that you can control, from the fall-path of the one in front of it. Depending on what your line of business is, this may entail realigning your business strategy, distribution channel(s) or even forming strategic partnerships.

Market risks have been the ultimate test for Company Boards and they will continue to present challenges. However, by using basic ERM tools such as scenario scans and stress analyses to answer questions such as; which dominoes are most likely to fall, or how hard will this domino be knocked by the one in front of it, companies can gain invaluable insights into what lies ahead in the uncertain future. Our market risk modelling tools are able to model these interrelationships. This does not mean that we are able to predict the future, but these tools help us in highlighting all the possibilities that may unravel – and therefore how best your business should adjust. The key is not to waste energy debating on risks you can’t change, but adjusting the links between that risk and your current risk profile…

This article is part of a Bluecroft Market Bulletin (July Release – page 14) to corporate clients in Zimbabwe.

》》 | ERM Solutions

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