As the festive season is upon us, we thought it would be fun to embrace the spirit of Christmas with a more light-hearted take on stress testing and liquidity planning. Christmas films might not seem like the obvious place to draw lessons on the topic, but as you’ll see, they’re full of scenarios that can inspire creative thinking.
So, as we all wind down and enjoy a little seasonal cheer, take a moment to enjoy a unique perspective from our Risk and Margin SME, Jo Burnham, on how holiday classics can offer surprising insights for navigating challenges. Let’s get into the Christmas mood and dive in!
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The festive season is upon us and I have a confession to make – I’m addicted to Christmas films. And it doesn’t matter whether it’s the good ones or the bad, made for TV ones.
And watching all these films can actually help with stress testing and liquidity planning. Bear with me here. Although they may have different story lines, they all involve some form of stress event. If you think about the details of each it can help you develop different scenarios, any one of which could help to avoid future liquidity issues.
There are various lists of “Top 10 Christmas Films” available so I’ve made my own. And each of these tell you something different, either about the type of event you should be considering or how you should be using them in your stress testing.
It’s a Wonderful Life
This one comes top in most people’s list of top Christmas films. The story of George Bailey, who is prevented from committing suicide by his guardian angel, Clarence, shows how actions taken and changes in behaviour can make a big difference.
This should remind you that it isn’t always the biggest market changes that lead to the biggest calls on liquidity, and that it is important to consider “no market change” scenarios and how your actions impact the requirements. As an example, just leaving positions to run to expiry could reduce the offsets available or change the level of parameters that apply, leading to huge increases in initial margin.
Die Hard
We can argue whether this is a Christmas film or not, but as it takes place on Christmas Eve I don’t see why not. I know Hans Gruber isn’t really a terrorist and he is just after the money, but it does show the impact that a terror attack can have.
And with the current geopolitical situation, new attacks somewhere in the world should probably be expected. Depending on where this happens and what is damaged, there is usually an impact on the markets. When thinking about the stress scenarios to use, it is worth considering how any increase in terrorist activity could impact the products in your portfolio. Look not just at what happened historically following major incidents, but also theoretically what could occur following a new attack.
How the Grinch Stole Christmas
There are a few versions of this, but my favourite is the Jim Carey version, probably because my dog looks just like Max, especially when we dress him as a reindeer!! Like Die Hard, the Grinch reminds us of the current geopolitical situation, and how one bad apple can cause devastation, ruining Christmas for all of Whoville.
The film hints at past events and the impact that can have on the markets, most recently for example the Russian invasion of Ukraine. And with the number of other autocratic leaders currently around the world, any one of which could instigate an event that could become the new top stress scenario, it is important to consider what could happen and how it would impact your liquidity requirements.
Trading Places
This is another film that isn’t obviously a Christmas one, although it does take place over the festive period. Regardless, it is the best film that there is about the commodity markets and, although the story was focused on frozen orange juice, because the writers thought it would be more amusing, it was based on real incidents, including a Russian attempt to corner the wheat market and efforts to corner the silver market that became known as Silver Thursday.
The most obvious similar recent event would be the LME Nickel crisis. This resulted in significant increases in margin requirements and strains on liquidity. It shows how important it is when designing stress scenarios to consider the impact of any attempt to manipulate a particular market.
The Snowman
The Snowman is mostly a really magical film, making snowmen and flying through the air to visit Father Christmas. But then it warms up and the Snowman melts. It shows the devastating effect that weather can have.
From crop failures to flooded warehouses, through transport difficulties to power shortages, weather can have an impact across the markets. Thinking of the potential effects is definitely a good source of stress scenarios.
Home Alone
Poor Kevin. Not only does he get ridiculed by his family and then left “Home Alone”, but he also has to deal with the blundering burglars. There are a lot of surprising events that he has to deal with. But then so do others; his family trying to get home despite the bad weather and the burglars trying to survive the booby traps set by Kevin.
What this film can teach us is to expect the unexpected. We’ve already seen examples of small changes having a big impact, the chaos caused by terrorist attacks and the acts of dictators, and the way that markets react to manipulation and bad weather. But being able to extrapolate this into an event that hasn’t happened yet could be the key to making sure that the next incident isn’t going to lead to liquidity issues.
Love Actually
Love Actually isn’t one story. It’s actually ten linked stories. And like the film, stress testing relies on multiple scenarios.
Any changes in a portfolio can mean that it is a different scenario that could result in the largest liquidity requirement. You need to be using enough different scenarios and styles of analysis in your stress testing to ensure that nothing is missed.
The Santa Clause
When Scott Calvin puts on the red Santa suit he unknowingly accepts all of Santa’s duties and responsibilities. In other words, he has been impacted by regulation. And this is definitely something that firms should consider when looking at future liquidity requirements.
Currently, commodity trading firms often switch trading from ETD to OTC in order to avoid paying Initial Margin. But if the regulation were to change and more firms were to be brought into scope of UMR then this would no longer be the case. And if some of the recommendations of the “FSB Review of Liquidity Preparedness for Margin and Collateral Calls” were to be translated into regulation, then it would become incumbent on firms to ensure they have robust stress testing in place.
Elf
Elf has all the normal Christmas film disasters and misunderstanding. But it’s the end of the film that can teach firms the most about liquidity planning. Santa has had to start using an engine to drive his sleigh because of the shortage of Christmas spirit that should be the propulsion. But when the engine is lost it takes a round of enthusiastic singing to generate enough Christmas spirit to get the sleigh flying again and save Christmas.
This is a good illustration of the advantages of having different trading strategies available. Whether it’s moving between ETD and OTC, trading the same product on different exchanges or looking at alternatives, such as LNG rather than Natural Gas, there are many reasons why firms should understand the impact of making these choices. Sometimes it’s just that choosing one rather than another will reduce Initial Margin requirements, but it is also about understanding what it will be possible to trade in times of stress.
A Christmas Carol
This is another film where there are a number of versions, but the only one for me is The Muppets version. I have to watch it religiously every Christmas Eve. The most obvious way that it can teach us about liquidity planning is the lessons it gives on the impact of changing behaviour. In the same way, adapting your trading strategy can help optimise any future liquidity requirements.
And the ghosts can also tell us a lot about the functionality required for best practice liquidity planning:
The Ghost of Christmas Past is like calculating Margin at Risk – using the current portfolio and historical market data to determine the largest likely margin requirement for a given confidence level.
The Ghost of Christmas Present is like running T+1 calculations – using latest prices and positions to be able to predict the next day’s margin call.
The Ghost of Christmas Yet to Come is like calculating Cash Flow at Risk – looking forward over different time horizons to determine the largest likely liquidity requirement for a given confidence level. And like for Scrooge, it could be bad news.
And as the end of the film shows, if you act on what the ghosts (or analysis) tells you and take the correct action then you should be able to prevent future liquidity issues.
Conclusion
So remember, don’t feel guilty if you find yourself watching lots of Christmas films over the festive season. They might just help you work out the most important stress scenarios for your firm and help you understand how to make significant improvements in your liquidity planning.