As the initial step to design the scenario, consider using the typical matrix to plot liquidity risks: (1) How fast or slow is the stress unfolding? and (2) Is it a market-wide stress or is it just happening to your institution? Most institutions (irrespective of their size) use this concept to identify their view on 'risk of liquidity', and consequently their mitigation measures. Any dry run thus needs to include consideration of the scenario that is to be tested. Our recommendation is to plan multi-year dry runs to address different relevant scenarios individually over time.
Any risk-inducing event will trigger breaches of early warning indicators (EWIs), provided they are well defined, and this in turn will trigger an escalation process to determine whether activation of the contingency funding plan is needed or not. Assuming a sufficient level of severity, the Crisis Management Team (CMT) will assemble, following a dedicated escalation process as defined in the CFP. Testing the ability to escalate and to come together in a timely manner (i.e., the response time) is fundamental.
After the stress event has been triggered and once the CMT is convened, the game is on. It is strongly advised to establish the rules of the game (e.g., the way of working, involvement of underlying teams, communication channels, logistics and IT, breakout rooms, et cetera) upon start, as well as to define clear boundaries such that the exercise progresses as designed, so it can be properly evaluated.
A liquidity contingency dry run has multiple angles, and so it can be assessed from many perspectives. It is important to agree upfront on what angles are to be tested, without revealing any details on this (or on the actual scenario) to the actual dry run participants. Below, we list some:
EWIs, escalation and convening the CMT: The EWI panel has to maintain the right balance between quantitative and qualitative indicators in order to identify, for instance, social media rumor storms driving reputational damage and consequently bearing direct impact on the liquidity position. Employees need to be trained to identify EWIs, perform an initial assessment, apply the four-eyes principle controls and timely escalate and activate the CMT.
The CMT dynamic: While the dynamic often differ across institutions (e.g. proactive vs reactive, hierarchical vs flat structure, constructive vs accusatorial, agile vs bureaucratic, etc.) it plays a pivotal role in ultimately shaping the response. Role clarity, hands-on and decision-making capabilities, ability to facilitate and steer discussion and make formed decisions are for example essential factors in this dynamic.
The ability to obtain and present data: In an ad hoc, fast-moving environment, it is crucial to streamline the request and reception of updated information in real time. The information needs to be requested clearly, processed timely, and brought to the right level for it to be useful during CMT discussions (C and C-1 level). Whether it is of a technical nature (e.g., LCR, liquidity buffer, outflow rate, asset encumbrance ratio, et cetera) or of a reputational nature (e.g., media articles and press releases, social media activity, rating agencies communication, et cetera), it must be clear how data should be presented to ensure consistent and informed decision-making.
The understanding of the CFP and how to execute the CFP in terms of deciding upon countermeasures: Clearly, this is at the core of the response, but it is surprisingly difficult to consider in a real dry run set-up. How fast can we sell off securities? Can we timely request emergency lines? How fast can we pledge additional collateral? Did we agree on taking any losses during sell-off?
Communication: Both internal (e.g., What employees need to be informed of the ‘new reality’? and Which guidelines can be used to ensure consistency throughout the organization?) and external (e.g., How are supervisory board members, shareholders, regulators, market participants, customers and media addressed? and What is communicated, when, and via what channels?). Additional considerations, such as external legal advice or disclosure restrictions, need to be clear from the beginning.
A crucial aspect of the design, which influences the aforementioned points, is the dry run set-up. Depending on CMT availability, desired complexity, and budget, dry runs can span from three to four hours to two to three days of dynamic events and changes of direction. Longer configurations typically allow for more realistic simulations, where concrete measures can be more thoroughly reproduced and tested (e.g., executing specific transactions, moving balances from/to different cash accounts, steering outflow payments, requesting emergency lines to the central bank, et cetera).
