Cash & Liquidity ManagementCash ManagementCash ForecastingBlack Swan Theory: What treasurers must do to navigate the rising probability of improbable events

Black Swan Theory: What treasurers must do to navigate the rising probability of improbable events

The increasing frequency of so-called “Black Swan” events is demanding treasurers embrace an array of new tools to mitigate risk

As highly improbable events such as the 2008 financial crisis, the pandemic, and most recently the Russia-Ukraine war, arrive with alarming frequency, treasurers must be wary of the unknown and protect their businesses from so-called black swan events, according to Jean-Baptiste Gaudemet, senior vice-president for data and analytics at Kyriba.

“There will always be uncertainty,” Gaudemet tells The Global Treasurer. “The best treasurers can do is to anticipate possible disruptions through a proper data-driven risk-management approach.

“It is important to have the ability to react to uncertainty.”

Beyond the horizon

Data science-based statistical models have been developed to help steer treasurers through the mayhem of black swan events.

“It is not a prediction but a quantification. The distinction is very important”, Gaudemet says.

“First, it is critical to understand that the black swan can happen and second, to be able to simulate the potential impact.”

But don’t wait until the calamity hits, he says, “you need to do this before the event arrives”.

Although Kyriba’s tools cannot specify in the data science precisely what kind of event lurks beyond the horizon, their solutions provide a cushion of liquidity and a level of comfort that treasurers require to mitigate the impact of such events on the business.

Patrick Kunz, founder and CEO of consultancy Pecunia Treasury and Finance, agrees that systems based on artificial intelligence (AI) and predictive analysis (PA) are unable to forecast black swan events that have caught treasuries unaware in the last few years.

“Most companies that have AI and PA-enriched forecasting would have terrible accuracy in current markets,” says Kunz.

“No [AI] could have predicted the Covid situations with their lockdowns, demand surges, supply chain issues among others. There is way more volatility in demand and turnover both to the negative and positive.”

Some treasurers, faced with the deficiencies of AI-reliant systems, have fallen back on simpler cashflow forecasting models because they believe they work better in current markets, according to Kunz. Once the markets stabilise and begin to function more normally, they plan to switch the AI-based logics back on.

What-if scenario analysis

Whatever systems are used, however, it’s imperative that treasurers are in full control of the situation.

“Without that control, the ability to make predictions about cashflow and other vital measures are worth nothing,” warns Gaudemet.

“Treasurers should ask themselves what they can put in place to ensure the resilience of the company.”

Ultimately, the defence mechanism comes down to “what-if” scenarios, he says. If a black swan event strikes and cashflow dries up, the what-if scenario provides accurate running assessments of the business’ liquidity among other vital metrics and, therefore, its ability to survive the crisis intact.

These are effectively stress tests similar to those that banks run on a routine basis. Generally, banks have led the way in shock-proofing the business, says Gaudement.

“Bank treasurers are very familiar with this approach. They have been equipped for many years with solutions that allow them to report risk metrics to regulators.”

His own company has developed statistical machine-learning models that give treasurers a high level of confidence in making decisions, for instance predictions of future cash flows.

“These tools empower treasurers to clearly define what-if scenarios,” he adds.

In the last few years, corporate treasurers have adopted different precautionary measures according to the nature of the business.

After the Lehman meltdown, Deutsche Post DHL set up a syndicated loan facility to guarantee access to credit in times of crisis, explained Stephen Hogan, vice-president regional treasury Asia Pacific, in an interview with the Association for Financial Professionals.

“We now pay to have committed credit lines in place because that’s what you need in a crisis,” he said, adding that DHL’s maturing debt is spread across several years to ensure refinancing is conducted over a wider time frame

Looking to the future, even the most risk-conscious treasurers need to get up to speed with highly calibrated tools that measure the likely impact of shocks rather than rely on intuition as many have done until now.

“It is important to be equipped with proper measurement tools that formalise how to protect the company,” says Gaudemet. “[It is about] rationalisation and automation that rely less on personal judgement and more on formal systems.”

Based on current demand, Kyriba sees a rapid uptake of these tools as treasurers learn to rely less on personal judgement and more on formal systems when they are faced with low-probability adverse scenarios.

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