Following a global pandemic, we are once again facing a significant stress event for markets – major conflict in mainland Europe. This scenario is typical of the sort of events that risk managers seek to model to test the resilience of their portfolios. What might make markets particularly nervous this time however, is the confluence of two significant outcomes: effectively a looming sovereign default (Russia and its banks being shut out of markets) and the current shocks in the commodity and energy markets as demonstrated by the LME having to suspend trading in some contracts.
There are various scenarios that could play out:
- Foreign banks with concentrated exposures to Russia facing significant losses: a Russian default is expected, with Fitch stating a default is ‘imminent’. While losses may well crystallise for banks, these are unlikely to be life-threatening with banks having scaled back exposures since the events in Crimea in 2014 and foreign banks having relatively modest exposures to Russia and its banks.
- Hedge funds and asset managers with large exposures to the Russian bond market: more significant in scale, and expect some large losses to materialise for those who have portfolios skewed to these risky assets. The rouble crisis in 1998 caused the demise of Long Term Capital Management and we may well see history repeating itself.
- Smaller trading houses with significant commodity exposures: the recent jump in margins at LME and other commodity and energy exchanges will put pressure on many, so some failures are to be expected.
In fact banks in particular are far more resilient and well-capitalised than in previous crises. Additionally, more trading activity is concentrated in CCPs who themselves have enhanced their capabilities which means that any defaults should be contained and any contagion avoided.
But even beyond these current crises, what will always be front of mind for risk managers is how to prepare for the unexpected.
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