The black swan that could come will definitely come

People usually think that most swans are white, and there are very few black swans, even if you look for one, you may not be able to find it, let alone run into it. In short, people regard the possibility of an extreme event like black swan happening to them as zero.

But it is not like that in reality. If you turn a blind eye to problems, muddle through, and take chances, a small problem will become big, and the black swan will definitely come. In fact it is almost impossible not to come. Why? Because the black swan is from within, not from Australia, and may look only a bit gray at this moment but can grow and will grow black, with the conducive condition and will form a vicious cycle with condition, thus can come quicker than you think.

Thus, if you see a gray swan, you must nip the possibility of its turning black in the bud in the first time. In fact, a risk manager’s job is to examine the seemingly white swan to prevent any black from developing.

Why do we have gray swans? The number one possibility is that we didn’t do things properly and we know. If that’s the case, address it, ask for help. It’s better to admit it’s gray before it turns to black.

The second reason is more fundamental, there are no white swans by nature in finance. They are white only because of the current climate and condition. As soon as those change, you will see gray and black. As a risk manager you need to know the relationship and address with proper approaches. In other words, you need to “think clear” first, only then you can address the issue.

The "think clear, do clear, and communicate clear “ doctrine is from the founder of CICC. I connect this with a core value of Morgan Stanley, where I worked before. That is “Do the right thing”. Think clear is usually not a technical or capability issue but an attitude issue. Only when you want to do the right thing, you can feel the urgency and make the effort to address the issue timely. Otherwise, there will be delays and cover-ups.

Take Bill Huang's Archegos incident as an example. His portfolio is not diversified enough to receive high leverage but he got. In addition, Nomura and Credit Suisse didn’t deal with situations well and timely. That shows the banks themselves are cultivating black swans. CS has not resolved their issues for years. When market climate changes, the possibility of swan blackening increases dramatically. Certain events then accelerate the process. It can be seen that it is very important and urgent to deal with the issues as soon as possible. Ignoring or delaying will lead to more troubles.

When your VaR or the Expected Shortfall say you will not lose money once in thousands of years, look further. These measures are static, they don’t tell you the dynamical process of swan blackening.

Do the right thing and “think clear”.