This guest article was written by Fred Gewirtz, senior account executive at think liquidity.
First penned by a Greek philosopher named Heraclitus sometime between 535 BC and 475 BC, the phrase was refreshed by Oscar Wilde in the play An Ideal Husband in 1895. While we claim to be neither philosophers nor dramatists, the wisdom imparted by the phrase is clearly evident to us. As a broker, expecting the unexpected should be part of your daily routine and hard-coded into your risk management practices.
Most trading days are normal days, broken up by the monthly or quarterly exception. The expected is what makes a normal day normal. Looking for the unexpected can be pure drudgery on a day to day basis, but it is work that can determine the success or failure of a firm. Some events have a known date, with an unknown outcome. Other events are unknown both in the date they will occur and the outcome. When an unfavorable result occurs with the former event type, it is often the result of a bad process. When an unfavorable result occurs from the latter event type, it can reveal a systemic flaw.
Your job as a risk manager is to ensure that things are operating smoothly on the normal days, as expected on the eventful days and without surprises on the unexpected days. That means you are looking to improve processes and identify the flaws that could be fatal to your brokerage. Over the past few years, there have been all types of events to prepare for. The Scottish independence referendum in 2014 was a good example of an expected event with an unknown outcome. The SNB’s unpegging of the franc was an example an event with an unknown date and an unknown outcome. In both cases, proper preparation for the potential fallout resulting from severe market volatility was vital.
This month, you should be preparing your firm for the British referendum (BREXIT) scheduled for June 23rd. While situations like these each have unique characteristics, your preparations from a risk management perspective should be consistent. Here are 5 proactive measures we recommended for previous events and are asking you to consider now:
1. Maintaining an open dialogue with liquidity relationships
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2. Raising margins
3. Adjusting swaps to discourage unbalanced positions
4. Reviewing the mix of A Book to B Book
5. Applying stress tests to measure the potential P/L impact under different scenarios
Having these conversations now helps ensure that you have the best plan in place for an event that could carry significant market volatility.
It’s our way of expecting the unexpected.