Christine Lagarde is not in the habit of mincing her words. The president of the European Central Bank confirmed this when, in January 2024, she raised the prospect of Donald Trump's re-election in the United States. "If we have to learn the lessons of history, i.e., the way in which he has conducted the first four years of his mandate, it is obviously a threat", she declared on France 2 TV.
More than nine months have passed since this warning was issued... without European financial institutions taking the measure of this "geopolitical risk", according to economist Bruno Colmant. This cross-cutting risk, which impacts other types of risk--market, credit, liquidity and operational--is associated by the former Belgian banker with the possible complete disengagement of the US from Ukraine and Taiwan, an isolationism that will "increase the vulnerability of its European allies".
On the financial markets, "there will be several impulses", noted Colmant. "First of all, we can expect stock markets to be euphoric about the deregulation and low interest rates associated with Trump. Isolationism could also galvanise American companies, and therefore the stock market. But in the longer term, the increase in US debt could weaken the dollar, as this debt could become so unsustainable that the Federal Reserve will be forced to refinance the US government directly."
Europe’s only option will be to cut interest rates.
Colmant--a former head of ING Luxembourg, the Brussels Stock Exchange and Degroof Petercam--fears a loss of independence on the part of the Fed, which risks being used by Trump to obtain low rates and refinance US debt. "In the long term, we should expect a stagflationary environment in the US, with high inflation - linked to protectionism and tax cuts - combined with weaker growth in the medium term. This inflation could spread globally."
This is why the ECB is "reluctant to cut rates too quickly", he said. "But in the event of a major financial slippage, Europe's only option will be to cut rates to prevent the euro from becoming too strong, and if that is not enough, to print money as we did in 2009." He interprets the rise in the price of gold as "a sign of a loss of confidence in the dollar", and recommends that investors do not focus solely on US assets, but diversify their portfolios.
Boards ‘not sensitive’ to geopolitical risk
, chair of the Luxembourg Association of Risk Management (Alrim), also condemned the lack of preparedness of financial institutions in the face of geopolitical risk, which is now reaching its climax. "There is a lot of denial. I attribute this to a tick-the-box culture, limited to compliance with prudential rules, and a lack of proactivity. Too many players wait until a regulatory text explicitly requires them to take a risk into account."
Among those responsible, the Neuberg points to boards of directors. “They are not yet sufficiently sensitive to this type of risk. Two years ago, , director general of the Luxembourg Financial Sector Supervisory Commission (CSSF), said at a World Economic Forum conference on geopolitical risk that virtually no board was well prepared for this risk. But the impetus has to come from the top, because we're talking about strategy here.”
In practice, Neuberg flagged the importance of stress tests to analyse the impact of geopolitical events on the portfolios and strategies of financial institutions. This involves collaboration between risk managers, strategists and economists. "The difficulty lies in constructing scenarios that are plausible but highly improbable. Not to mention the fact that in the event of a disruptive event for the business, such as a thermonuclear cataclysm for example, the exercise no longer makes sense."
The stress test is an extremely powerful tool, but it cuts both ways.
These complex stress tests obviously have a cost, which comes up against budgetary constraints. According to Neuberg, who represents Luxembourg's risk managers, this makes it difficult for smaller players to implement effective geopolitical risk management. "It is the big asset managers who devote resources to stress testing. They also see the value in it because they have a track record and have lived through crises."
Stress tests are also sometimes imposed by the authorities. When asked to comment, the CSSF would not say whether it carries out tests on, for example, changes in the value of US debt or the dollar. "The CSSF monitors risks in investment funds on the basis of reports and other data at its disposal. This information enables the CSSF to closely monitor the geopolitical risks linked to the US elections and to identify any problems with a view to taking the necessary measures", the regulator stated.
"The stress test is an extremely powerful tool, but it cuts both ways", explained Neuberg. "To communicate on the subject is to reveal a fear about this or that risk factor. This is not in the interests of either the financial institutions or the supervisory authorities, given the risk of panic and the negative signalling effect it could generate."
Read the original French-language version of this news report