MANAGING EMERGING SYSTEMIC RISK

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Alan Laubsch

Director, VP of Risk Products

View of smoke plumes emitted from the Syncrude upgrader plant north of Fort McMurray, northern

Alberta, Canada. Photograph: Jiri Rezac/Jiri Rezac. Source: guardian.com

Systemic Implications of the Global Energy Meltdown

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Market linkages Clustering

Bilateral exposure data Asset price data Balance sheet data

Financial Cartography reveals connected

risks and hidden patterns

Central nodes

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How can we best manage emerging

systemic risk?

As in healthcare, our best chance lies is early detection

Source: MULTIPLE SCLEROSIS: ORIGIN OF ABNORMAL CELLS

FOUND, UC DAVIS (2011)

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GLOBAL ENERGY MELTDOWN

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What Precipitated the Energy Tipping

Point in 2014?

Systemic implications?

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Canary in the coal mine: Energy

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Classic contrarian phase transition

1. Low vol (complacency)

2. Peak prices

3. … and then an outlier

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24 June Risky Business Report

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Divestment Tipping Point

Litterman believes an immediate risk

that investors should address is the

potential for "stranded assets," or

energy sources companies will not be

able to harvest as the cost of oil, natural

gas, coal and other fossil fuels increase

from carbon-related taxes.

"It's a risk management issue. Fossil

fuel companies aren't evil or bad—

they're acting rationally given the wrong

incentives. The incentive to emit is not

being penalized today," Litterman said

during a panel discussion on money

management in the face of global

warming.

"The risk that investors have in their

portfolios is not climate risk, per se, it's

the risk that assets will be repriced

because appropriate incentives are

created globally to conserve on

emissions."

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Train Wreck

Source: Bob Litterman: The Price of Climate Risks

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Stranded Asset Swap

Source: Bob Litterman: The Price of Climate Risks

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22 Sep 2014: Rockefellers Divest“John D Rockefeller, the founder of Standard Oil, moved America

out of whale oil and into petroleum….We are quite convinced that

if he were alive today…he would be moving out of fossil fuels and

investing in clean, renewable energy.”

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9 Oct Risk Crescendo

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Oct 9 Energy as worst performer

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Oct 9 Energy EAFE correlation

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28 Nov Black Friday

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28 Nov Black Friday

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Given inevitability of carbon pricing, was

OPEC’s decision surprising?

Given that we have

exceeded safe levels of

atmospheric CO2, carbon

pricing or limits are

inevitable.

Paradoxically, until these

costs are imposed,

producers will keep

pumping

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Black Friday cascaded into 10-15 Dec

EMBI & Russia Crisis

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15 Dec Oil & EMBI correlation peaks

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Predictive Stress Black Fri 28 Nov 2014: -

3sd Oil & Energy

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Predictive Stress 9 Oct 2014:

-3sd Oil & Energy

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Systemic Risk Escalating in 2015

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Energy & Junk bond correlation still high

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30 Jan: Oil up 6.6% but bottom unlikely

Dead Cat Bounce?

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Predictive Stress 30 Jan 2014:

-3sd Oil & Energy… some decoupling

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Energy (XLE) vs S&P 500Asymmetric downside beta since 24 Jun 2014

Peak Energy

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SUMMARY & CONCLUSIONS

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Subprime Energy Bubble Bust

Carbon intensive industries/countries most vulnerable

- Equity, Credit, FX.

- Commodity bubble bust? Materials

2n order effects: Financials exposed to Energy &

Materials? Utilities? Liquidity risk.

Monitor systemic risk & focus on early warning

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Disruptive Energy “Dragon Kings”

The future is already here. It’s just not very evenly

distributed. - William Gibson

Alternatives

Divestment

Carbon Price

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Adaptive Stress Testing

Source: Wikipedia; see Geoffrey Moore’s “Crossing the Chasm” (1999)

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Conclusions

1. See a Connected Picture of Risk

2. “Sense and Respond”

3. Amplify Social Intelligence

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FNA

Alan Laubsch

Director & VP of Risk Products

alan@fna.fi www.fna.fi

Thank You