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Black Swans: practical considerations for your risk management programme
Practical Law UK Articles w-007-4474 (Approx. 4 pages)
Black Swans: practical considerations for your risk management programme
by Practical Law In-house
| Published on 06 Apr 2017 • International |
An article providing an overview of the Black Swan concept, what some suspect could be Black Swan events in 2017, and some practical considerations for your risk management programme.
Nassim Nicholas-Taleb coined this term in his 2007 book, The Black Swan, with the theory that a Black Swan event must have three attributes:
- It is an outlier, beyond the realm of regular expectations, because experience cannot point to its possibility.
- It carries an extreme impact, which could be catastrophic.
- After the fact we produce explanations for its occurrence, making it explainable and predictable.
Put more simply, Black Swans are a rarity, with extreme impact, and only retrospective predictability. These are also often called ‘unknown unknowns’ and can be negative, such as the Fukushima disaster, or positive, such as the Harry Potter phenomenon.
For many, the fact that these are considered 'unknown unknowns' means that they have not been built into traditional risk management planning. If you cannot know what the risks are or even see them coming then nothing can be done.
Nassim Nicholas Taleb argued at the 2015 MetricStream GRC Summit that our corporations, industries and economies have become fragile and a breeding ground for Black Swan events to occur. Arguments supporting this include:
- Technological innovation has transformed the way that we do business and with opportunities, it has introduced points of weakness and vulnerability.
- Complacency or comfort with the status quo.
If this is correct, then Black Swans can no longer be left in the periphery of a risk management programme but must be actively incorporated within it.
How do Black Swans fit into a risk management programme?
More traditional risk management programmes rely on the identification and planning around risks based on the experience and knowledge of the teams involved in the risk assessment exercise. If a risk is outside of the experience or knowledge of this group, it is unlikely then to be considered and built into the programme.
Despite foresight being contrary to the very principle of Black Swans, you can ensure that you are quick to identify one when it occurs and to efficiently react to its consequences, both positive and negative. The risk management programme should:
- Ensure awareness of the Black Swans concept through the management structure up to and including the Board.
- Benchmark and learn from what others do around Black Swans. See Case Study: managing a Black Swan crisis where Natalie Prosser talks to Practical Law about Ofqual's 2012 Black Swan event.
- Counter complacency by regularly seeking an independent view of what could be a Black Swan event for your business. This can be done by any or a combination of bringing in external experts, reviewing market research or analysing third party data.
- Horizon scanning – what may be a Black Swan for you may not be a Black Swan for others and vice versa.
- Ensure that you maintain an up to date and relevant serious incident policy which guides the business on what to do in the event of a serious incident/crisis, such as a Black Swan event, occurring. You must ensure that there is awareness of this policy through the business; where needs be, this should be published in all working languages.
- Focus on resilient business continuity plans, including the allocation to individuals of roles/responsibilities within the plan. You cannot audit the value of these plans without running some incident scenario exercises; consider running these at different levels within the organisation from Board/Exec through to the local business.
- Ensure that you regularly review, stress-test and where necessary, qualify supply chain alternatives.
- Encourage long-term planning – businesses often focus on a 1-2 year planning horizon however some emergent trends take time to diffuse.
- Ensure that your public communications policy incorporates what can and cannot be said in the event of a crisis or Black Swan event. Like all policies, this must be effectively and regularly communicated.
- Consider how you will ensure that your day to day business will continue to run whilst handling the Black Swan event. This will require considering how you manage and counter the psychological effects of such an event which will commonly include stress, fear, shock, panic, disbelief, anger, denial and even grief.
- Learn from those instances where the business has handled a risk or Black Swan event. What worked well? What needs more consideration? What effect should these 'lessons learnt' have on the risk management process? In Case study: Ofqual's novel approach to risk assessment, Ofqual's risk team to talks to Practical Law about comparative judgement, the 'regulatory engine' and a risk perception exercise.
There are additionally strategic considerations that go hand in hand with this planning – what can the business do or have in place in order to react quickly? For each it will be different but think about the following:
- Ensuring access to cash and/or a line of credit to allow you to make immediate cash outlays if required.
- Cross-training of personnel to increase workforce flexibility.
- Incorporating in any event management planning a review of any emergent opportunities.
What are potential Black Swans for 2017?
Contrary to the concept of being incapable of being foreseen, there are those who have chosen to put the 2017 events that they see as potential Black Swans down on paper.
Barclays Bank has given the following list of commodity Black Swan events:
- Iran/US rhetoric escalates and leads to more Iranian ballistic missile testing. Any rising tension between the US and Iran could adversely impact investment in Iran's oil sector which could bring about a short term rise in oil prices.
- Venezuela defaults on its 2017 debt obligations.
- Large-scale water contamination issue caused by wastewater disposal incident.
- Riots in Chile over the 2017 general election results halts production of copper, impacting both price and supply.
- Russia pushes further into the Ukraine, disrupting iron ore production.
- Economic downturn in any of the major commodity consuming nations. China is the world's largest consumer of most commodities; any slowdown in its economy would depress demand for commodities, such as iron ore and copper and be reflected in rising prices.
- Escalation of trade war with China leads to geopolitical tensions.
- Elon Musk delivers Model 3 on time or a battery breakthrough. This may lead to a more rapid adoption of electric vehicles and potentially a drop in oil prices.
- Broader US/Mexican trade war makes US natural gas exports into Mexico uneconomic.
- Fukushima-type incident in China turns public opinion against nuclear power.
- North Korea nuclear tests.
- China deploys a rig to drill in the disputed waters of the South China Sea.
- Further terrorism in Turkey could affect gas and oil markets.
The Telegraph has also identified the following potential Black Swan events in 2017:
- A tech crash in China.
- A Baltic market collapse.
- More countries join the EU.
- Facebook merges with Apple.
- Trump trade war with Germany.
Whether true Black Swans or not, these are some the events that could occur in 2017; there are, of course, many other potential events which could have a catastrophic impact. If any relate to or will have an effect upon your business then it is worth building more specific considerations around them into your own risk management plans going forward.