In 2007, The Black Swan: The Impact of the Highly Improbable, a book by Lebanese-American public intellectual Nassim Nicholas Taleb was all the rage. The book highlights how unpredictable events – ‘black swans’ – can have extreme impacts with severe negative repercussions, and calls for adequately preparing for, rather than predicting, these events.

Since the global financial crisis (GFC) – the period of extreme stress in global financial markets and banking systems between mid 2007 and early 2009 – and despite the robust regulatory reforms enacted across the global financial sector, the world has still not been shielded from another similar meltdown.

Fast forward to recent times, and the financial sector is facing a period of severe macroeconomic and geopolitical stress and uncertainty riddled with all sorts of traditional and novel risks. It is clear that financial institutions and asset managers are facing an ever-more complex set of interrelated challenges which require proactive and robust principles-based risk management processes.

Against this backdrop, in November 2023, PwC published the latest edition of its well-received Global Risk Survey,  which highlighted how certain organisations, spread across all industries and sectors, are ‘Risk Pioneers’ that not only manage to effectively navigate risks, but see them as opportunities to achieve value amidst uncertainty.

Today, building on the Global Risk Survey, PwC Luxembourg has released its new report “From Compliance to Competitive Advantage: Risk and Performance in a Fractured World” which can help financial institutions in Luxembourg and the rest of Europe to not just think about and anticipate ‘black swans’ in the coming years, but to see them as potential opportunities and emerge as ‘Risk Pioneers.’

From the Cold War to today

The report analyses in detail risk management’s “Long and Winding Road”.  Starting with the end of the Cold War when free trade came to be seen as the key to spread prosperity to all four corners of the world leading up to today.  As the report clearly demonstrates, periods of high or even extreme stress have happened in the not-so-distant past. From the Dot.com bubble to the GFC, the European Sovereign Debt Crisis, the COVID-19 pandemic and the Russia-Ukraine conflict and all its attendant macroeconomic convulsions, asset managers cannot afford to adopt a complacent attitude to the risks that lie ahead. From traditional risks – such as market and credit risks – to novel risks related to geopolitics, ESG and technological changes, asset managers are now confronted with a whole new dimension of risks which could severely threaten bottom lines and asset valuations.

The report emphasises how the risk management function cannot, and should not, be a mere box-ticking exercise. Firstly, as they are empowered to ask pertinent questions whenever investment decisions being considered could pose a high risk, risk managers in the fund industry need to proactively ensure that principles-based good governance with open channels of communication are implemented throughout the firm. Secondly, risk managers need to keep a keen eye on the novel and compounding risks surrounding the asset and wealth management industry.

As for the tools at the risk manager’s disposal in this high-volatility context, commonly practised tools – such as Value at Risk (VaR) and the like – despite their usefulness, cannot simply be used as a routine compliance function whose original purpose has been forgotten. Risk managers in the asset and wealth management industry should consider a whole host of approaches, such as stress testing and reverse stress testing, as well as all potential risk triggers and how they are interconnected with one another, in order to persevere and thrive in the new context.

Benjamin Gauthier, Partner, Regulatory, Risk and Compliance Leader, says:

“The current turbulent macroeconomic and geopolitical context should be seen as an opportunity for asset managers to update their risk profiles, thoroughly examine and revamp their risk management processes and frameworks, adopt a whole host of risk assessment methods such as reverse stress testing, and integrate risk management into all operational facets. By enacting such policies, they would not only strengthen their own resilience and be better prepared for potential future heterodox shocks, but would also be able to capture new value creation opportunities and remain competitive in an industry facing a whole host of challenges.”

Olivier Carré , Deputy Managing Partner, Technology & Transformation Leader, PwC Luxembourg, says:

“Technological developments are proceeding at breakneck speed, from ever-sophisticated cyber attacks and malware, to innovative developments in the AI sphere and their potential to bring forth untold productivity gains. Risk managers need to familiarise themselves with how such changes can impact both a portfolio’s value and the firm itself, and ensure that the firm is not only digitally resilient in an operational sense – in line with the EU’s DORA – but that it is also well-positioned to make the best of the opportunities presented by technology without exposing the firm to extensive risks. Doing so would allow firms to adequately deal with new operational risks, such as the challenges of attracting and retaining qualified staff with the right skill sets.

As for ESG risks, a failure to properly take them into account can lead to substantial drops in a portfolio’s value at the slightest extreme weather event, as well as reputational harm which can quickly spiral out of control. In the worst of cases, such risks can lead to intense regulatory scrutiny, penalties, and an irreparable breach of stakeholder trust which can ultimately contribute to the firm’s demise.”

Time to adapt risk management strategies to fit the current era. The time has never been more apt to emerge as a ‘Risk Pioneer’!

Download the full report: “From Compliance to Competitive Advantage: Risk and Performance in a Fractured World”