April 2021
Citi GPS: Global Perspectives & Solutions
Solutions for Addressing Systemic Risk What can we learn from the insights of these two leading lights from the world of risk? The key takeaways from our illuminating conversation with Mark Carney seem to be as follows. Scenario analysis and stress testing are essential to understanding the
risks and opportunities. The scenarios should encompass business-as-usual, a smooth transition, as well as ‘Minsky moment’ scenarios incorporating abrupt change on the policy and financial sides, and on the social side in terms of loss of social license to operate.
Common disclosure and reporting, for climate change specifically, on a scope
1, 2, and 3 basis are a critical starting point.
Building risk-management skills, including diversity of background,
perspective and thought processes, time horizons, and risk tolerances can reduce blind spots and biases in these processes; in particular getting beyond the ‘greater fool’ theory, and the naïve belief that market participants will be able to ‘get out’ before systemic risk materializes. Understanding mismatches between data liquidity and expected asset liquidity when systemic risk strikes is also key.
Improved understanding of corporate strategic resilience and resiliency of
portfolios and assets, whether physical or financial, to low-frequency, highimpact events with uncertain timings and interconnections and interlinkages which are not immediately apparent should result from a combination of the above points, providing the opportunity to take corrective action, via prudential buffers, strategic re-alignment etc.
Managing systemic risk is an issue for both the public sector and the
private sector. The public sector has an extraordinary ability to signal clearly the pace and direction of travel of public policy, thereby achieving pull-forward effects, much as with central banks and interest rate policy, as these policy actions are transmitted into financial markets, with private capital then essentially making the result a fait accompli. As an example, clear government policies on carbon, with potentially an integrated global carbon market and coordinated and comprehensive scope 3 reporting, would allow natural capitalism to drive the process of change on climate very effectively.
Similarly, the key takeaways from the insurance perspective from our interview with Dame Inga Beale are as follows. Getting more capital into the insurance industry and making that capital
stay there. It appears that a key stumbling block is the quantum of the liabilities versus the amount of capital in the insurance industry. Innovative financial instruments might provide a solution, particularly in a broad and liquid market, which could provide a portfolio/diversification benefit.
The balance of players and risk. It seems the insurance industry is reluctant to
cover larger liabilities — having a propensity to step back, because of the government stepping in and providing a backstop — which creates a vicious cycle of a lower propensity to take out insurance. This is in some ways reminiscent of challenges financing the UN SDGs, to which blended finance has often been postulated as a solution.
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