Introduction

We all know that the past 18 months have been pretty tricky – to say the least. The lack of, or the ignoring of, proper risk management, not to mention the quality of regulatory oversight at global investment banks, has read like a financial soap opera. Whether it was an alleged rogue trader at Societe Generale, or a risk manager at HBOS who was sacked for doing his job, too many stories simply point to flaws in cultures or procedures that may have contributed to the current economic crisis.

These examples of poor risk control, now compete alongside dramatic episodes of fraud and deception such as the Maddoff ponzi scheme or the amusing ‘he said/she said’ back and forth that is part of the history of the Bank of America/Merrill Lynch merger.

It may be better to view 2008 as the year, not when the banks fell apart, but when the true value of risk management became evident.

Looking at risk from that perspective, 2009 will be the year of the Risk Manager. This Informatica-sponsored White Paper will examine the top five trends that emerged from the events of 2008 and look at how the financial community plans to respond to those trends.

• Data – There are those that argue that banks and investment firms need access to a single global database of trade and reference data. While that mythical day may never come, most banks are aiming for a global, consolidated risk database to ensure that all their risk engines are fed by the same, consistent data.

• Technology – A number of banks are now looking to increase their capabilities around ad-hoc risk management processes. For instance, risk managers now want the ability to run one-off stress tests and scenario analyses, and their IT strategies have to be adapted to meet this demand.
• Regulations – Given the turbulence and ongoing volatility across the global markets, numerous institutions and organisations have been, and are under, the spotlight. Although financial innovation and engineering has become increasingly sophisticated, it has certainly not been regulated with 21st century regulatory frameworks and methodologies. This has caused immense pressure on the regulators to introduce new initiatives in the regulatory space.
• Communication – There needs to be a fundamental change in which communication is played out in risk divisions. Open communication generates an atmosphere of honesty, which in the current economic climate is appreciated by staff. This new found ‘honesty’ generates discussion on fundamental issues that need to be addressed in investment banks such as culture, systems and methodologies.
• Buy-side and Hedge Funds – One firm in particular noted that its approach to hedge fund risk had not changed that much over the past 18 months except that it is now charging more in upfront margin/collateral and any exceptions to standard policies and procedures must be better justified and supported by senior business management.

Conclusion

It may be bold to say that risk management in financial investment firms had only been given lip service for the past 10 or so years. Despite scholarly talk about the Chicago-method and the years of wrangling over Basel II, risk management was seen as an academic exercise. Risk departments presented their findings to their banks’ boards and in turn those boards decided whether or not to act on those findings. Global regulators, for that part, seemed complacent in these proceedings.

The process into whether a board of directors regarded risk reports and limits as a directive or a suggestion was influenced by many factors. Did the board have sufficient knowledge of risk management in order to understand the risk findings? Does the risk staff have the amount of personal skills to communicate, and in some cases push, for their views to be heard-never mind followed.

How accurate or complete was the data surrounding so many of these toxic assets that are sitting in banks’ balance sheets? When the boom times were rolling in places like Wall Street and the City of London, most banks did not care that the amount of reference data on CDOs was accurate or even available. However, when the trading cards came tumbling down, many banks found they had no way of knowing where their exposures lay in these markets.

So, where do we go from here? Both the IT departments and interest from the buy-side has shown increased investment in risk management. The next few years in financial services could be the age of the risk manager. However, despite increased IT budgets and improved and centralised data stores, one thing remains consistent. Most banks say that it will take the heavy hand of the regulators to raise the status of risk management at investment firms.

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Tagged with: 2009, credit crunch, Executive Summary