Traditional risk models are failing to account for the unprecedented and interconnected systemic risks of an increasingly uncertain world, according to PwC Luxembourg’s latest report: Megatrends: Five global shifts reshaping the world we live in.
The report argues that continued reliance on traditional risk models is problematic, as they can fail to account for the ripple effects of global disruptions increasingly prevalent today. A more agile and holistic risk strategy, combining data-driven analysis with qualitative insight, is necessary, said PwC, integrating ESG risks into core frameworks and using scenario planning to build geopolitical and economic resilience. This should strike a better balance between embracing technology and managing cyber and compliance threats.
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Therefore, PwC advocates the use of reverse stress testing, a method whereby financial institutions first define what could be a catastrophic outcome for them, and then work backwards to identify what factors could plausibly lead to the occurrence of such an outcome.
PwC also identified five major ‘megathreats’ — climate change, technological disruption, geopolitical instability, demographic shifts and sovereign debt crises — that pose growing risks to financial stability. These are explored through six high-impact scenarios, including the drying of the Panama Canal, a coordinated BRICS sovereign debt cancellation and a bursting of the AI investment bubble.
Such ‘megathreats’ should be reviewed annually at the board level to ensure firms stay ahead of accelerating global risks, PwC added.
Benjamin Gauthier, partner and regulatory risk and compliance leader at PwC Luxembourg, said: “We are publishing this report to encourage financial institutions to engage in deep reflections and rethink how they prepare for increasingly complex and systemic risks.
“The scale and speed of today’s threats demand more than traditional risk models. Firms need to challenge assumptions, act before crises strike and build resilience through forward-looking, practical strategies and reverse stress-testing. Preparing for uncertainty must now be a core part of doing business, not a reaction after the fact.”
Last year, research from the Thinking Ahead Institute showed a growing awareness of systemic risks, with 88% of the world’s largest investment teams – representing $6trn in capital – expecting systemic risks to grow in incidence and size, with the main challenge for global investors being the management of complexity.
Meanwhile, last week, UKSIF, Scottish Widows and Canbury outlined their own rationale for an enhanced focus on systemic risk in financial services, with a clear framework for action to embed systemic risk management as part of investment objectives.
