The scope and breadth of the coronavirus (COVID-19) represents an unprecedented shock to the world’s economies, communities, and societal norms. The rapidly evolving nature of the crisis very potently demonstrates the continuing importance of considering future pathways, potential consequences, and how best to respond.
The previous post began by stating: “the global coronavirus pandemic is very clearly a rapidly evolving, complex, multi-factor event with significant downside potential over both the immediate short and medium-longer terms”. This post further explores the virus under the lens of a set of key principles we believe are fundamental to effective emerging risk analysis:
- focus on multi-factor scenarios ahead of single factor stresses – a couple of moderate adverse events occurring at the same time are more likely to be the cause of business failure than a single extreme tail event;
- consider a wider set of measures than just the balance sheet impact – many seemingly severe stresses can look quite benign (or at least manageable) from a capital perspective, but could well have more concerning implications for a firm’s liquidity, its operational integrity, or considering the potential response by key stakeholders;
- develop novel scenarios that involve aspects or dynamics that the business has not previously encountered – these tend to be more challenging to manage, situations that have happened before are generally well understood and firms should have plans in place to deal with them appropriately should they arise again; and, finally
- recognise the highly complex, highly interconnected nature of today’s business environment (and the wider world) – this creates emergent outcomes that are highly non-linear and which can unfold unexpectedly and at high velocity.
A multi-factor event
Firstly, the present situation would not be in any way accurately described as an event for which the only impact is a direct near-term shock to mortality and morbidity rates. Beyond the infections and deaths, in past weeks, markets have responded turbulently with dramatic falls in equity prices, credit spreads widening significantly and sovereign yields falling to new lows. Most firms have already had to respond to the increasingly strict social distancing measures, which present challenges in terms of both staff and customers. As an unfolding risk event, the crisis can today be characterised by demographic, market and operational risks that have already crystallised.
Looking forward, the only aspect that can be reliably predicted is that the multi-faceted nature of the crisis will continue. From a demographic perspective, in the UK it is widely acknowledged we are perhaps a few weeks behind other European countries in terms of infections. It is an unknown whether the newly announced measures will be effective or are, in fact, being introduced too late. Furthermore, assuming current or increased social distancing measures prove impractical or undesirable to enforce beyond a few months, there are expectations of a second significant spike in infections towards the end of the year. And over the longer term, even with a vaccine (which estimates suggest will take 18 months to develop), the virus could establish itself as an ever-present threat in much the same way as seasonal flu. On a more positive note, researchers are already making good progress with advances in testing, which would potentially allow those who have already had the virus to be identified and returned to work quickly and safely.
Further market falls and sustained volatility should also be anticipated, and initial hopes of ultimately seeing a “v-shaped” recovery in markets appear to be fading fast. It is far from certain that the economy will be able to pick back up where it left off once the virus infection rate subsides and mitigating measures are phased out. There is also the question of whether the coronavirus was the sole cause of the severe market falls or instead triggered a crash that was already primed and waiting to happen, with the risk being obscured and delayed by macroeconomic measures such as depressed interest rates and quantitative easing. In the latter case, fundamental economic weaknesses will need to be addressed in addition to stopping the virus before we can return to economic growth. In the intervening period, we can anticipate a dramatic drop in corporate investment spending as well as increased default rates and company bankruptcies. The effects of the virus might have a lasting impact on factors such as the size of the workforce and consumer demand.
Operationally, the option of working from home will not be practical for certain industries, and with recommended or mandatory social distancing measures in place, many firms will find it extremely challenging (in some cases impossible) to maintain their business-as-usual capacity and capability. Others firms that transition to remote working will nevertheless face their own challenges, not least of which is the need to be mindful of the potential for reduced staff productivity, engagement and morale.
Whatever the type of business, the direct challenges to maintaining the day-to-day functioning of business will need to be managed alongside an increased exposure to existing operational risks. Likelihoods of occurrence will, in many cases, be materially elevated. For example, malevolent cyber actors may view the spread of the coronavirus as an ideal opportunity to launch a targeted or wide spread cyberattack and empty offices/facilities, remote working and supplier restrictions over an extended period all raise the prospect of operational failure.
Furthermore, every firm’s ability to respond to and recover from the occurrence of any operational risk events will also be materially impaired. Existing post-event mitigation and recovery plans will (almost without exception) be designed around incidents lasting a matter of weeks, not months or longer. And they will invariably rely on having people on the ground and readily available outside resources and expertise, replacement equipment and cash to meet a significant, short-term spike in expenditure. None of these can be taken for granted. Firms will need to reassess both their assumptions regarding the availability and efficacy of recovery measures and their own internal definition of what constitutes “recovery”.Continue reading