Presentation on a new risk synthesis

ACCA FS NETWORK FORUM | RISK MODELS

© 2013 Paradigm Risk Limited. All rights reserved 1

The elements of a new risk synthesis and the role of financial models in managing risk

ACCA FINANCIAL SERVICES NETWORK FORUM

Whether financial models manage risk 27 February 2013



Context

•  Focus on context of risk modelling not the activity of risk modelling

•  Place risk modelling in the context of governance and the firm’s risk system •  Rebalance the debate – putting people back in the equation

•  Introduce a model of risk synthesis





All models are wrong, but some are useful . . .



George Box, professor of statistics��University of Wisconsin–Madison, 1987



All models are wrong, but some are useful . . . The practical question is how wrong do they have to be to not be useful.!



George Box, professor of statistics��University of Wisconsin–Madison, 1987



data!

controls!

modeling! capital!analytic core"

The analytic core

•  Effective risk governance puts the firm’s analytic core at the centre of decision-making (the so-called “use test”)

•  Data is the starting point for robust modeling

•  Modeling forms the basis of capital target-setting, allocation and capital pricing (charging) in the firm



systems!

deployment! limits!

controls!

use of risk analysis"

behaviour"drivers"

data! modeling! capital!analytic core"

Systems & controls Central to reliability

•  Sound control over systems and robust data governance are essential for reliable modeling

•  The firm’s data architecture is central to its risk management capability

•  Systems provide the platform for limit-setting deployed throughout the firm

•  Effective control over systems is essential and a vital aspect of robust assurance



risk strategy!

risk framework"

appetite | tolerance"

analytic core" data!

systems!

deployment!

controls!

limits!

modeling! capital!


behaviour"drivers" risk competencies |"

The firm’s risk strategy

•  The firm defines (models) its risk strategy through sensitivity (tolerance) to its capital position at a target level of performance at a preferred level of implied risk (appetite)

•  The firm communicates and operationalises its appetite and tolerance through its risk framework

•  The firm’s risk decisions are only as good as its people (competencies) and their understanding of risk objectives



governance!

risk & internal governance"

assurance"

data!

systems!

deployment!

controls!

limits!

risk strategy!

risk framework"

modeling! capital!


analytic core"



Governance Corporate governance | Risk governance

•  Effective risk governance ensures the firm’s capital is central to all discussions about risk

•  Risk governance and internal governance (legal vs operating) structures should align clearly

•  Risk review and oversight are critical aspects of risk governance

•  Robust assurance is required over data & modeling and risk operations



data!

systems!

deployment!

controls!

limits!

risk strategy!

risk framework"

governance!


assurance"

modeling! capital!


analytic core"



A coherent approach linking the analytic core to governance

•  Effective risk governance is about eliminating silos so the firm views its risk in an integrated way

•  Effective risk governance is a component of effective corporate governance and cannot exist separately from it

•  A firm committed to a robust response to the challenges of Solvency II must address the quality and performance of its corporate governance



Avoiding jargon about ‘corporate governance’

•  The term ‘corporate governance’ has become so widely used that its meaning can be unclear

•  All forms of governance are subsets of corporate governance

•  Robust risk governance is a central aspect of effective corporate governance

•  Effective risk governance requires that the firm manage explicitly the relationship between subsidiary structure and subsidiary risk reporting, control & oversight

•  At operating level, ‘governance’ is synonymous with management, oversight & assurance

Corporate governance

External governance

Risk governance

Internal governance

Company compliance

Board performance

BOARD LEVEL

Corporate secretary

EXECUTIVE LEVEL

Data governance

Programme governance OPERATIONS

Subsidiary structure

Subsidiary boards

Crisis fitness

Risk strategy

Risk framework

Risk system

Shareholder relations

Capital structure

Risk management !& operations

Subsidiary operations



MANAGERIAL

ALLOCATIVE / "DECISIONAL

OBJECTIVIST

A new risk synthesis 1/2 : Elements of the synthesis

structural



A new risk synthesis 2/2 An organising framework

data!

systems!

deployment!

controls!

limits!

risk strategy!

risk framework"

governance!


assurance"

modeling! capital!


analytic core"





Guns don’t kill people . . .



Conclusions We need a new risk synthesis

•  ‘Solutions’ have focused on the easy bits – structural and analytical solutions

–  witness the solutions of the Walker review

•  Risk management in a firm is a human system – behaviour is essential . . .

•  . . . and unpredictable •  Therefore firms’ risk systems behave like complex adaptive systems •  Linear control solutions will be ineffective

•  Behaviour has been reasoned out of the equation

•  We need a new synthesis reintroducing behaviour as a core element and as a feedback loop to make risk systems effective . . .

•  . . . meaning attention (in the technical sense) to behaviour so . . . •  Financial models don’t manage risk . . . ��

People manage risk using financial models with apologies to the NRA



www.paradigmrisk.com

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Presentation on a new risk synthesis

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