Risk Management Top Concerns

I keep replaying a recent conversation about risk in my head. You know how it is. Someone says something that does not make sense and you ponder why he or she fails to see what is obvious to you (and to many others). Let me explain.

The speaker (whom I will call Bill) asserted that concerns on the part of an unnamed fiduciary about the risks associated with investing in a particular structured product should be given short shrift. He reasoned that no explicit losses had occurred during a date range certain so why bother with thinking about a "what if" world. According to his logic, anticipatory hedging or other type of risk control methodology would be counterproductive.

I could not disagree more with the view that no news is good news. 

Any competent risk professional will describe the nature of an effective mitigation program as forward-looking. Sometimes a review of past failures can be helpful in terms of understanding what could have been done differently. That's not to say that history dictates the future. Change occurs and ignoring new rules or market conditions or other salient facts makes little sense.

Effective risk management is a process that includes steps such as those listed below:

• Identify possible problems before they materialize;
• Use a risk map or similar tool to neasure the probability of occurrence and likely economic impact should an adverse event occur;
• Evaluate competing risk mitigation techniques in terms of costs, benefits and unique circumstances for the investor or service provider such as an asset manager;
• Create approrpriate policies and procedures to ensure adequate data capture and benchmarking of the chosen technique;
• Implement the selected strategy or technique;
• Regularly review technique for efficacy; and
• Modify the risk management actions as needed.

Textbooks and "lessons learned" white papers are replete with examples of what might have been done in advance to avoid past monetary loss or untimely death or injury. Notably, the concept of loss is not confined to negative outcomes. Opportunity loss is likewise important. A dictionary defines the term as "loss of availability," "loss of prospective benefit," "loss of readiness" or "loss of productivity."

Contrary to Bill, I don't believe that one should sit idle when it comes to risk management. Fortunately, at least some in in the financial sector are focused on the high price tag of ignorance. According to a Deloitte survey of large investment management firms, sixty-five percent intend to expend more on risk management and compliance, citing concerns about the quality of risk data, technology and "lack of integration among systems." In a 2014 assessment of the banking industry by the Centre for the Study of Financial Innovation, with support from PwC, non-bankers fear that "banks are vulnerable to weak corporate governance and risk management..." at the same time that "many respondents said that banks had made risk management an urgent priority over the last couple of years."

Benjamin Franklin is attributed as saying "By failing to prepare you are preparing to fail." How true