London Evening Standard: Perils that lie in risk management: “…it is less than 10 years since Shell was vilified for its environmentally sensible proposal to sink the Brent Spar oil platform in the Atlantic, and thereby introduced the world to reputational risk.”: “Regulators, auditors, ratings agencies and even businessmen speak of little else these days. A whole new science has grown up to meet the need.” (ShellNews.net)
15 October 2004
IT hardly bears thinking about but it is still less than 10 years since Nick Leeson brought down Barings bank and introduced the world to the concept of operational risk.
Similarly, it is less than 10 years since Shell was vilified for its environmentally sensible proposal to sink the Brent Spar oil platform in the Atlantic, and thereby introduced the world to reputational risk. In that age of innocence, no one talked about risk control.
Regulators, auditors, ratings agencies and even businessmen speak of little else these days. A whole new science has grown up to meet the need.
Now that it is flourishing, it is time in that British way to have doubts. Last night under the chairmanship of Sir Howard Davies, the London School of Economics hosted a debate entitled Are Risk Managers Dangerous? The thesis was that in the past decade, banks, investors and company bosses have invented ever more clever ways to deal with risky markets.
They have created sophisticated mathematical tools to analyse the risks they face. They have dreamed up complicated 'derivatives' and new forms of insurance to slice up risks and sell them to the people who want to bear them the most.
The debate sought to explore whether risk managers create an illusion of safety without delivering the reality. They have, after all, been at the centre of corporate disasters such as Enron. Have the practitioners of the new profession of risk management done more harm than good?
The arguments have two strands. Avinash Persaud, investment director of hedge fund GAM, took the line that two views are needed to make a market but modern risk control systems all basically work to the same principles, and so they will all deliver warnings at roughly the same time, meaning everyone will rush for the exit at the same time. Systems that provide individual protection collectively create, or threaten to create, an even greater systemic instability.
Professor Michael Power, on his home turf, followed a line he delivered earlier this year in a lecture entitled The Risk Management of Everything. His thesis is that society requires professionals to give their honest judgments on the problems of the day but the culture of risk avoidance is leading to defensive medicine, defensive auditing and defensive legal opinions - and an absence of the honest opinions society needs if it is to function properly.
Thus management consultants, auditors and the rest spend huge amounts of time considering whether or not to take on a client because they are worried about the risk to them if something subsequently goes wrong. The companies most in need of the best auditing therefore tend not to get it because they are not taken on as clients.
Most people will recognise the problem and see that it is not confined to risk managers. When a group gets a skill, in risk management, treasury, IT, compliance or whatever, it uses that skill to start building empires and, before you know it, is tacitly conspiring with outside agencies - be they regulators, government or rating agencies - to pile on extra work which allows them to build their empires even bigger.
They very quickly lose sight of the fact that they are there to help business make a profit and grow. Instead their lives revolve about doing what they do, whether or not it furthers the fundamental aims of the business.
A PRIVATE client stockbroker of more than 30 years' standing told me the other day that he saw no future for private client advisory stockbrokers as we both understood the term. He believed that the volatility in markets and the attitude of the Financial Services Authority now made it impossible to recommend shares to clients.
He therefore thought that within a few years, brokers would instead advise clients on which unit trust, investment trust or hedge fund should get their money. In other words, they would advise their clients on the choice of fund manager but would no longer try to manage funds themselves.
The reason, he said, is that the FSA has made it impossible to continue in the old way. If, for example, two clients have a medium-risk portfolio, the FSA will expect both to perform identically.
It will not accept that some clients don't want to sell because they hate capital gains tax, some will not buy tobacco or drinks shares and some have other preferences, all of which will mean that portfolios with identical risk will not deliver the same performance.
The attitude of the regulator, however, is that the one with the lesser performance must have been mis-advised or short-changed in some way and so it gives the broker a suitably hard time.