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Financial Services Study Reveals Emerging Tech-driven Systemic Risks

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Accelerated technology adoption in the financial services sector is creating new systemic risks to the global financial system, according to a new report. Beneath the Surface: Technology-driven systemic risks and the continued need for innovation is the first publication in the World Economic Forum’s two-part Technology, Innovation and Systemic Risk research initiative.

Prepared in collaboration with Deloitte, the report explores the relationship between increased technology adoption and the potential shock of cascading risk factors – for example, the domino effect that can result when hackers, disasters or geopolitics expose interconnected financial systems to a growing array of known and unknown vulnerabilities. The research additionally examines actions that can address identified risks, including the role that technology itself can play in mitigation approaches.

“This comprehensive study aims to establish a sector-wide understanding of technology-driven risks, and deliver insights for all stakeholders,” said Drew Propson, Head of Technology and Innovation in Financial Services, World Economic Forum. “Not only is it essential that we have full awareness of what these risks are and how they are building upon one another, but equally important is true collective action around solutions. The need for continuing innovation, and for multiple financial sector entities to increase collaborative efforts, couldn’t be more critical as we work toward risk mitigation.”

Key takeaways

Over the past year, approximately 200 financial services and technology experts engaged in a series of global workshops and interviews, insights from which formed the basis of the report findings. Research outcomes reinforce the need for leaders within the financial services ecosystem to have a solid understanding of today’s risk environment, and for them to embrace experimentation with new mitigation applications that hold the potential to enhance current efforts.

Problems highlighted in the report include lagging cyber defence mechanisms, increasing business disruptions, talent scarcity, climate change imperatives and rising geopolitical tensions. The data emphasizes that virtually any entity within the interconnected financial services ecosystem, large or small, can cause or be caught by the impact of network disruptions.

Digital interconnectedness. As the number of interlinkages between service providers grows, private and public sector leaders should remain conscious of their external relationships. Broader vendor networks with third, fourth and fifth parties can be monitored through new forms of technology while reducing over-reliance on a single vendor’s shared capabilities. However, while new monitoring capabilities can be enabled by as-a-service providers, leaders must be aware of the trade-off of adding to ecosystem dependencies that create another source of operational risk.

Regulatory alignment. Certain entities within the financial services ecosystem are not currently under the purview of financial services supervision and regulation. Tackling systemic risks outside financial networks remains in the formative stage and concerns of non-bank systemic importance grow as operational failures or cascading cyber attacks on vendors become harder to trace across the ecosystem. This is especially the case as the traditional determinant of an entity’s systemic importance is primarily based on its size of book, or total assets, which is becoming less relevant than its size of network, or total digital interconnections. Public sector players need to examine the range of emerging activities to ensure a consistent taxonomy and adequate regulatory coverage that appropriately defines the scope of oversight across these activities.

New incentives for multilateralism. While many emerging use cases of systemic risk mitigation are being developed in collaboration, there is no industry-wide vision of the future across most jurisdictions. And while the potential for technology to enhance risk mitigation is undeniable, addressing systemic risk must start with the basics. Without a common understanding in the form of frameworks, principles and standards, fragmented efforts and siloed information make global prevention of systemic risk difficult.

Closing the gaps

The report cites examples and important lessons to be learned from recent events such as the SolarWinds breach, where a digital supply chain attack compromised almost 20,000 interconnected companies including major financial institutions and IT vendors. The proliferation of such contagious, backdoor breaches is forcing a reassessment of systemic risk management strategies and the implementation of unified standards. Ideally, future gaps can be identified before destructive events occur. The ability to take collaborative action to close such gaps is equally essential.

“Among the numerous actions that our industry must take, there are two areas of immediate concern to us,” said Rob Galaski, Vice-Chair and Deputy Global Leader, Financial Services, Deloitte. “First, we must move toward safe sharing of risk-based data across institutions and jurisdictions. A global network will always be able to detect and neutralize threats more effectively than individual actors. Our second concern speaks to the modernization of regulatory frameworks. For example, ‘systemically important institutions’ are currently defined by traditional measures of balance sheet size and a dated notion of what constitutes a ‘financial institution.’ As our report points out, new measures such as size of network should also be considered when determining systemic significance.”

The report concludes with encouragement for a collaborative new risk agenda. It highlights core questions that public and private sector leaders can consider as they assess their organizations’ capabilities and resilience against systemic risks of the present and future.

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Amidst Strong Economic Rebound in Russia, Risks Stemming from COVID-19 and Inflation

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Following a strong economic rebound in 2021, with 4.3 percent growth, Russia’s growth is expected to slow in 2022 and 2023, with a forecast of 2.4 percent and 1.8 percent growth, respectively, according to the World Bank’s latest Regular Economic Report for Russia (#46 in the series).

The Russian economy has now recovered to above its pre-pandemic peak, with growth driven by a strong rebound in consumer demand. In 2022, growth will be supported by continued strength in commodity markets, but will likely also be hampered by COVID-19 control measures and tighter interest rates.

Household consumption in the second quarter increased to more than 9 percent on the previous quarter (seasonally adjusted), showing the fastest rate of growth in a decade. Labor markets also saw a substantial upswing, with unemployment falling to a four-year low and real wages growing.

Russia’s current account surplus has also been exceptionally strong, on the back of high commodity prices and low levels of outbound tourism. The federal budget has been consolidated, led by a strong growth in revenue, and is on track to meet the authorities’ target of meeting the fiscal rule next year.

“This surge in spending resulted from the release of pent-up demand created by pandemic restrictions,” said David Knight, Lead Economist and Program Leader, World Bank. “It was aided by increased credit, Russian tourists staying at home for the holidays this year, and resource inflows via the energy sector.”

The report assesses the short-term risks weighing on Russia’s growth and finds that  low vaccination rates are necessitating stricter COVID-19 control measures that may reduce economic activity, while more persistent inflation will likely call for tighter interest rates for a longer period, limiting the growth outlook.

The report also analyzes how Russia could be impacted by global economic growth under three different green transition scenarios, and suggests that domestic climate action can help mitigate some of the possible impacts of a global green transition and create new opportunities for Russia.

The country’s new low-carbon development strategy, which aims for a 70 percent reduction in net emissions by 2050 and net carbon neutrality by 2060, will become an important first step for Russia. A focus on enabling the transition to a more diversified and faster growing economy will call for strengthening of a broad range of assets including human capital, knowledge, and world-class market institutions.

“Environmental sustainability is becoming central to the global economic agenda. Increased commitments by countries and firms to carbon neutrality signal that wholesale changes to policy frameworks will be needed in the coming years,” said Renaud Seligmann, World Bank Country Director for Russia. “With Russia’s pledge to become carbon neutral by 2060, the country now needs to take concrete actions of moving towards decarbonization.”

To accomplish these goals, the report recommends the implementation of carbon pricing and the consolidation of energy subsidies for consumers in Russia. At the same time, measures should be taken to ensure people are protected from the costs and any adverse impacts of the transition.

The report estimates that consumer energy subsidies on electricity, gas and petroleum in Russia amounted to 1.4 percent of the country’s GDP in 2019. By redeploying these resources, the authorities could increase GDP and ensure that no consumers are left worse off. At the same time, this would help reduce greenhouse gas emissions and move Russia closer to its goal of a green and sustainable economy.  

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World trade reaches all-time high, but 2022 outlook ‘uncertain’

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Global trade is expected to be worth about $28 trillion this year – an increase of 23 per cent compared with 2020 – but the outlook for 2022 remains very uncertain, UN economists said on Tuesday.

This strong growth in demand – for goods, as opposed to services – is largely the result of pandemic restrictions easing, but also from economic stimulus packages and sharp increases in the price of raw materials.

According to UN trade and development body UNCTAD, although worldwide commerce stabilized during the second half of 2021, trade in goods went on to reach record levels between July and September.

Services still sluggish

In line with this overall increase, the services sector picked up too, but it has remained below 2019 levels.

From a regional perspective, trade growth remained uneven for the first half of the year, but it had a “broader” reach in the three months that followed, UNCTAD’s Global Trade update said.

Trade flows continued to increase more strongly for developing countries in comparison to developed economies overall in the third quarter of the year, moreover.

The report valued the global goods trade at $5.6 trillion in the third quarter of this year, which is a new all-time record, while services stood at about $1.5 trillion.

For the remainder of this year, UNCTAD has forecast slower growth for the trade in goods but “a more positive trend for services”, albeit from a lower starting point.

Among the factors contributing to uncertainty about next year, UNCTAD cited China’s “below expectations” growth in the third quarter of 2021.

“Lower-than-expected economic growth rates are generally reflected in more downcast global trade trends,” UNCTAD noted, while also pointing to inflationary pressures” that may also negatively impact national economies and international trade flows.

The UN body’s global trade outlook also noted that “many economies, including those in the European Union”, continue to face COVID-19-related disruption which may affect consumer demand in 2022.

Semiconductor stress test

In addition to the “large and unpredictable swings in demand” that have characterized 2021, high fuel prices have also caused shipping costs to spiral and contributed to supply shortages.

This has contributed to backlogs across major supply chains that could continue into next year and could even “reshape trade flows across the world”, UNCTAD cautioned.

Geopolitical factors may also play a role in this change, as regional trade within Africa and within the Asia-Pacific area increases on the one hand, “diverting trade away from other routes”.

Similarly, efforts towards a more socially and environmentally sustainable economy may also affect international trade, by disincentivizing high carbon products.

The need to protect countries’ own strategic interests and weaknesses in specific sectors could also influence trade in 2022, UNCTAD noted, amid a shortage of microprocessors called semiconductors that “has already disrupted many industries, notably the automotive sector”.

“Since the onset of the COVID-19 pandemic, the semiconductor industry has been facing headwind due to unanticipated surges in demand and persisting supply constraints…If persistent, this shortage could continue to negatively affect production and trade in many manufacturing sectors.”

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Small Businesses Adapting to Rapidly Changing Economic Landscape

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The World Economic Forum has long been at the forefront of recognizing the strategic importance of sustainable value creation objectives for business. While interest has mostly focused on how large corporations contribute to the global economy and sustainable development objectives, small and mid-sized enterprises (SMEs) are often overlooked as major drivers of economic activity, as well as social and environmental progress around the world.

A new report released today finds factors that previously disadvantaged SMEs can lead them to new opportunities. Nine case studies from multiple industries and regions highlight what SMEs can do to increase their future readiness.

Developed in collaboration with the National University of Singapore Business School, the University of Cambridge Judge Business School and Entrepreneurs’ Organization, the report also finds that SMEs are lagging behind in terms of societal impact. Although there is a clear need to operate in line with sustainability goals, many SMEs have yet to include explicit strategies and performance measurement centred on societal impact.

The top challenges cited by SME executives include talent acquisition and retention (for 52.5% respondents), survival and expansion (43.8%), funding and access to capital (35.7%), non-supportive policy environment (21%), the difficulty of maintaining a strong culture and clear company purpose and value (20%).

SMEs can leverage their size, networks, people and the strengths of technology to support their goals of sustainable growth, positive societal impact and robust adaptive capacity. While it is essential for SMEs and the wider economy to increase their future readiness, they can thrive only insofar as the necessary supporting infrastructure and regulatory frameworks exist.

“We hope this will inspire and encourage SMEs and mid-sized companies to harness their potential in becoming a major driver of sustainable and inclusive economic growth and innovation by focusing on several core dimensions of future readiness,” said Børge Brende, President, World Economic Forum.

“Through this report, the Forum aims to highlight the significant role SMEs can play not just locally but also globally. The New Champions Community is a step towards bringing these smaller companies into the forefront of global discourse around socioeconomic development and engaging them in a community of forward-thinking companies from across the world,” said Stephan Mergenthaler, Head of Strategic Intelligence and Member of the Executive Committee, World Economic Forum.

The report aims to develop a deeper understanding of organizational capabilities and orientations needed for SMEs to successfully generate lasting financial growth, affect society and the environment positively, and develop high levels of resilience and agility.

It relies on robust research methods and combines rigorous primary and secondary research. The takeaways and conclusions presented in the research have been derived from an analysis of over 200 peer-reviewed articles and engagement of more than 300 CEOs and founders of SMEs through surveys and in-depth interviews.

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