A Catalyst for Good? Risk Management

COVID-19, A Catalyst for Good? Part 3 | The Impact on Risk Management


August 13, 2020

KRM22,which I lead, was set up to help reduce the cost and complexity of the risk management in capital markets with vision to allow firms to operate effectively at their optimum level of risk - what we call "Risk as Alpha".

The Capital Markets are well used to assessing risk but were blind sided by the sudden and dramatic impact of COVID-19. It is worth noting that it was not all downside and in fact many were lucky and benefited from the high volatility and hence volumes of trades. Getting lucky is not a strategy and although positive for many, a reassessment of risk appetite, risk controls and in particular the broad church of enterprise risk is needed. The reassessment should include howto ‘join the dots’ and to look at how to identify the early signs of a crisis,to allow time for mitigation actions. This is as well as the macro consequences of a crisis on the going businesses. These reassessments need to be not only on one’s own business, but also those businesses in which funds are investing and those the business is dependent on.

Risk Management in Capital Markets

Classically we think of catastrophic risks with a real blind spot .‘Pandemics happen in third world  countries’, ‘earthquakes rarely affect developed countries’, ‘fraud can’t happen here’, ‘we have firewalls, so we won’t be hacked’! All a symptom of blind spots. A renewed awareness of holistic risk assessment is needed. Enterprise Risk that has been around for years is now on the front line. Risks that affect businesses fall into a few buckets. Some scenarios are easy to assess and to establish controls and thus mitigation. For example, technology failures, credit exposure in normal market conditions or resource dependencies. What is tougher to do and often gets ignored is risk scenario assessment of impact of catastrophic events. Good enterprise risk management should address these significant stress events.Doing nothing is taking a position, put in ‘trader’ language! These catastrophic scenarios must be considered in the light of the risk appetite of the board. Certain risks are so severe that they threaten the very existence of a business if they occur. What I call a binary risk scenario. The tragic Beirut explosion is an example of a this. The consequence on human life and the economy meant that it was a risk that cannot be allowed to happen. But it did as we know. We can’t roll the clock back on the Beirut incident, but we can use it and the pandemic as a wake up call to actively access stress scenarios on our businesses and actively take a position.

The overall immediate financial impact of the pandemic may not have been seen until all trades have settled and all provisions for potential bad debts have been assessed. It is probably that there are ‘walking dead’ businesses, as the full impact on corporate customers has not flushed through the economic system. There will be a second and potentially third wave of impact as the ‘heroin’ of furlough payments and loans underwritten by governments work their way through the economic system. These actions have bought time, but not eliminated the risk. The point is there is still time to reassess risk and to mitigate against those risks that are still to materialise.

Adopting Enterprise Risk Management

Capital Markets businesses have been woken up to Enterprise Risk and that they need to move into a more dynamic assessment. No longer a monthly or quarterly process run by a remote, under resourced team but a process that links actively into the daily risk assessment and is linked to the individual accountability regimes regulators are implementing. The business ‘pilot’s’ must have their controls with live feeds around them as they ‘fly’ their business looking at near term risk as well as catastrophic risks. Enterprise risk should not be what gets done at group HQ, it’s a mindset change to have it adopted at business division or individual department level. Where risk can be better assessed, mitigated,and monitored. In fact, it is a culture change.  

There were many practical market risk experiences to learn from that were outside previous norms. The CBOE Vix went to 89, negative oil prices and negative interest rates,although that has been seen before. It called for more sophisticated and deeper market risk stress scenarios and assessment of mitigation actions. Market risk is generally considered though three windows, pre trade, at trade and post trade.These windows are not wrong, but what is importance is to look at the market risk through the continuum of the trades. Stress scenarios need to dynamically impact pre and a trade risk limits.

The regulators have made it clear that all businesses are expected to operate within the rules even through stress periods. Pandemics are not a free pass on bad behaviour with compliance rules. Systems and process need to effectively operate,any time, any place for those accountable under the Individual accountability regimes. A reassessment of policies and processes in this new hybrid home -office working mode is required.

KRM22, how can we help?

We designed KRM22 business infrastructure from day one to be leverage SaaS based business systems and so have been operating from our home offices since the lock downs. We have increased our internal communications across our team so all can stay up to date and fully engaged. Externally we have refreshed our web site to improve information sharing with customers and prospects and you will see more from us on social media as we try to stay in contact and share knowledge. With no conferences virtual networking is key. Our offering continues to develop on an integrated basis our across Enterprise, Market and Compliance risk domains. All delivered though our Global Risk Platform. Please register for our newsletter to stay up to date with KRM22 offering.

We look forward to helping our current customers and prospects reduce their cost and complexity of risk and prepare for the unexpected!