It was not long ago, when Dr. Nouriel Roubini (or infamously called “Dr. Doom” for having predicted the 2008 financial crisis back in 2006) was speaking of a necessitated market correction and was calling for the repricing of riskier assets; predicting a continuation of a global financial slowdown, or even a global recession starting in 2020. That was based on known factors affecting the global economy, such as the US and China trade war, Brexit, Middle East friction between US & Iran and the reduced forecasts of global economic growth to an estimated 3% compared to 3.4% the year before.
What that prediction did not take into account, was the unforeseen outbreak of COVID-19 and the increased volatility this has brought to global financial markets. 3 months on from the initial outbreak, and we have already witnessed the biggest intraday drop in the Dow Jones Industrial Average. The outbreak, coupled with the oil price shock, triggered responses from the Federal Reserve, the Bank of England and Central Bank of Canada to cut benchmarks rates in an effort to even out the shock to the wider economies.
There is a high degree of uncertainty on how the coronavirus crisis will unfold. We could experience only a temporary disruption - lasting from a few weeks to a few months, or a prolonged stress in markets, assuming that it will be months until vaccine clinical trials begin and with rate cuts (already reaching bottom) having limited effects on the required stimulus.
Banks have undeniably improved their liquidity following regulatory guidance post financial crisis, however, treasury departments will need to prepare and caveat for a wide range of possible outcomes. Traditional stress testing, scenario development and re-calibration have not taken into account conditions such as the ones experienced with the COVID-19 outbreak or the speed with which things evolved.
At a generic level, there are three key steps Treasurer’s should look to take:
This is already being considered by some of the larger financial institutions under their crisis management responses. However, it’s important to highlight that even for those that have triggered the crisis management process, the forecasting, rebalancing and risk assessment should be continuous, taking into account new developments in the following manner:
Continuously monitor and develop scenarios of potential sources that could disrupt funding and liquidity usage. With the right analytical capability, cash-flow projections should adapt to changing scenarios, including scenarios coming from the different business lines. Scenario sources could include:
Take immediate actions in increasing liquidity and cash holdings in the short term to cover for the uncertainty
Account for emerging risks previously not accounted for, such as the temporary closure of operations or reduced capacity of market utilities. Assess those scenarios and how these are captured and factored in stress tests. Intraday liquidity should be the primary focus to understand immediate cash requirements.
Better identification, measurement and analysis of key liquidity drivers should become core for an institution’s ability to effectively manage and mitigate particularly unique risks not previously considered. To do this, Treasurers should consider:
Increase frequency of monitoring to daily stress tests and daily Early Warning Indicator testing to include daily developments
Re-run your liquidity risk identification exercise to understand better your current exposures, especially examining certain instances of this outbreak crisis, e.g. oil-related exposures, airline, marine or supply chain related exposures etc.
Re-assess existing scenarios or add new scenarios in covering a range of events and timeframes (e.g. sustained spread of the virus over x months vs limited spread and containment). Revisit your Early Warning Indicators to monitor emerging risks. At a later point, revisit these to assess if market signals existed and if they were picked up by your indicators.
Identification, assessment and measurement is only part of the overall response. Stresses or risks that can be crystallised need to be accompanied by mitigative actions, agile and feasible enough under the current market conditions. Contingency funding actions might need to be revisited to determine if additional actions need to be considered.
Revisit and verify the availability of near real time reports, such as positions of securities holdings reports. Such information should be readily available and synthesised in the event that you will need to communicate clear and concise plans to investors, regulators or other market participants in relation to liquidity management strategies to foster confidence in the market.
Reviewing and preserving an institution’s liquidity under extreme and volatile circumstances is the core responsibility of any treasurer. However, we know that any scenario or contingency planning is unlikely to be fully predictive of unprecedented scenarios such as this. Re-visiting already set practices and testing their efficacy and completeness should be the first step before considering inserting new scenarios and new actions into the mix. Nothing tried and tested can always remain true.