• BCMstrategy, Inc.

QOTD -- Scenario Analysis After COVID-19

Today, the European Securities and Markets Authority (ESMA) said publicly what risk management experts have known for months: the regulatory assumptions and parameters for stress testing and scenario analysis were superceded by pandemic-related volatility. More stringent regulatory requirements are inevitable in the near-term:

These shifts will carry a slow-motion impact on corporate treasurers, asset managers, and bank customers throughout 2021. More stringent assumptions and parameters will generate quiet changes to regulatory capital requirements and customer credit limits, just as policymakers hope to see a dwindling pandemic and an economic recovery.


ESMA may be the first to notify markets of a shift in policy, but they will not be the only regulator seeking to update oversight mechanisms in light of lessons learned from 2020.


Risk managers seeking to get ahead of the curve will start assessing their own parameters and assumptions now....even if they are not subject to ESMA oversight. As we noted recently HERE, "Emergency measures taken during the pandemic (which we blogged about at the time), complicate considerably the risk measurement and risk management process. Traditional estimation methods based on historical data are of questionable utility when so many government guarantees, regulatory relaxations, and subsidies inhibit loss-generating actions by borrowers. Because these measures are temporary and directed to a uniquely exogenous event, they also embed an abnormally high amount of public policy risk into portfolios that ordinarily would be insulated from public policy risk."


Official action by regulators in Europe to begin reconsideration of model parameterization means those that start re-assessing their modeling process now will be positioned well both to hedge exposures and generate alpha when the great post-pandemic unwind begins.

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By BCMstrategy, Inc.

©2020 by BCMstrategy, Inc.