Good Risk Governance Pays - Investment Best Practices | Risk Management | Valuation

After the last few years, it seemed that risk managers were finally getting their due respect. Alas, a new survey suggests that more work remains to be done. According to "Too good to fail? New challenges for risk management in financial services" by Rob Mitchell with the Economist Intelligence Unit, "Inculcating and embedding a stronger enterprise-wide risk culture remains an ongoing challenge."

Sponsored by SAS, this March 2011 inquiry (and June 2011 report) finds that organizations still grapple with complexity, with about half of the 315 executives expressing concerns that their "employer's risk management processes are well placed to deal with volatility" and roughly one out of three organizations being able to thoroughly vet tail risk. (Note that "tail risk" is typically defined as the chance that investment prices or returns will be "extreme" in that realized performance falls outside of three standard deviations from the average.)

Other findings of the survey suggest that the risk management function is getting support, albeit limited, from atop the corporate food chain. More than forty percent of respondents announce that "their management boards have beefed up their risk expertise." One-half of polled professionals claim that "their boards are demanding more rigorous risk reporting."

A central message of the survey is that risk management reforms are underway but that risk management needs to be seen as less of a support function and more of a strategic mainstay that addresses organizational fortunes on a holistic basis. When asked about areas in which the skills of risk management professionals should be improved, one out of every three respondents cite the "ability to see the interdependencies between different categories of risks to the organisation."

Main barriers to effective risk management include regulatory uncertainty, "poor communication across departments," incomplete data, absence of authority for the risk management role, "lack of adequate investment" and poor real-time "(intra-day) risk management." With Basel III looming for a 2019 implementation, systematically important financial institutions ("SIFIs") could see profits lowered as capital requirements tighten, forcing more and better attention to be paid to the relationship between the cost of offering various products and services and risk mitigation.

In Risk Management for Pensions, Endowments and Foundations, Dr. Susan Mangiero talks about the urgent need for training across functions and job titles so it is alarming that 44 percent of respondents cite a 7 percent drop in the risk management training of the general workforce in 2011 from 2010. Fifty-four percent of risk executives describe a 9 percent decline in data quality and integrity with mergers and acquisitions leading to a related problem of disparate information technology systems. Without a good process in place to collect information, it is hard to measure and manage risks thereafter.

At a time when risk management is arguably as important as it has ever been in terms of protecting enterprise value, Financial Times reporter Justin Baer writes that "US regulators are warning banks to protect their risk-management staff and systems from any planned cost cuts as Wall Street grapples with a challenging year of meagre results." "US banks warned against shedding risk staff" references the Senior Supervisors Group of global bank regulators as urging financial institutions to do much more in the area of building a robust risk mitigation infrastructure.

Should an elephant fall, the audience will hear a thud. Should global financial institutions give short shrift to improving risk management policies, procedures, systems and practices (for those companies for which this applies), the economic "noise" will be deafening. Now is not the time to move backwards with respect to risk management.

Note to Readers:

• Click to read "Observations on Developments in Risk Appetite Frameworks and IT infrastructure," Senior Supervisors Group, December 23, 2010.
• See "Too Good to Fail? New Challenges for Risk Management in Financial Services" for a summary of the 2011 SAS sponsored survey conducted by the Economist Intelligence Unit.
• Download "Life in Financial Risk Management: Shrinking Violets Need Not Apply" by Susan Mangiero, AFP Exchange, July/August 2003. Note that BVA, LLC now does business as Fiduciary Leadership, LLC.
• Click to order Financial Engineering: The Evolution of a Profession by Tanya Beder et al (John Wiley & Sons, 2011).

According to today's news reports, the U.S. Securities and Exchange Commission may soon investigate the California Public Employees' Retirement System ("CalPERS") for its disclosures about inherent risks. If true, this type of inquiry could quickly lead to serious trouble for other public retirement plans as well as ERISA plans. For that matter, any issuer of securities (government or corporate) will be fair game if it's found that the investing public was ill-informed about the ticking time bombs associated with underfunded defined benefit plans, mismanaged 401(k) plans or both.

No public information has yet been made available on the topic of CalPERS and a federal regulatory examination so it is imprudent and inappropriate to speculate.

On a general note, at a time when investors are still reeling from losses in 2008 and 2009 and questions abound regarding the rules of the game, transparency and conflicts of interest, the last thing plan sponsors should do is to gin up their performance numbers. It's better by far to get the bad news out and deal with the aftermath in a legitimate fashion. One constructive approach is to engage a risk management expert to conduct an assessment of current economic vulnerabilities and how those risks are being communicated to bond buyers (and, for corporations, equity investors).

Email Dr. Susan Mangiero, CFA and certified Financial Risk Manager if you would like information about what a risk disclosure assessment entails for your organization or on behalf of a client(s). You may likewise be interested in one of our workshops for directors, trustees and/or members of the investment committee about performance reporting within a fiduciary and financial risk management framework.