A Shareholder Spring For Risk Management?

I was at a meeting last night supporting a friend who is trying to get some finance industry working groups together, groups that will bring their experience to bear on the key issues facing our business and our economies.

I won't steal the thunder as it is early days and the group needs time to formulate its thoughts and construct its messages. The two interesting areas for consideration are the unexpected consequences of regulation that is inteneded to reduce risk, yet in its hastey formulation and rushed implementation creates new and different risks and the second is the question of enterprise risk management ie if and how one can manage risk holistically across the business rather than in silos and pockets.

Both seem to be good areas that can benefit from the combined experience and wisdom of the group.

What struck me, and maybe I am just late to this party, but how great a conflict there is between the management of P&L and the management of risk.

In the latest deacle at JPMorgan it appears that Jamie Dimon instructed his Central Investment Office to "take more risk" and generate more income with the surplus of client deposits the bank was holding, yet when they do and they make a loss as they have done, it was not his fault. How does that work.

Of course there are some that seem to think that managing risk is the elimination of loss, but that seems rather naive. The bigger the risk the greater the possible deviation from the standard - both ways - positive and negative. To me risk management should be about protecting, as far as is possible, an institution from developments (usually losses) that would be catastrophic and precipitate the end of that organisation.

Can someone who is driving and heavily rewarded on growing P&L really be objective about managing the related risks. It is always hard to prove a double negative, so who could one be rewarded for correctly and prudently avoiding something that did not happen during the period in question? Measuring share values and money in the bank is so much easier.

So where am I going with this?

Well it seems that the regulators keep pushing organisations to look at certain risks, despite there being considerable debate about the definitions and overlaps between, market risk, counterparty risk, operational risk, etc, etc. Each accumulate rules and spawns its own culture and structures, costing money that detracts from the net profit - so you can see the tension. There was a comment about optimising regulatory compliance, with the suggestion that some organisations cannot comply with everything - there is so much - so they are assessing the next costs (cost of implementation and fines) and deciding which rules they cannot afford to fail with and which they can. Ironically that process introduces its own risks.

The other piece is that when all this compliance and regulation started in the 1980's ( I was around and remember) those who went into compliance and risk roles came from a business background. They knew how it worked and could operate with that perspective. Now 30 years on we have career risk managers and compliance officers who have never operated in the business - they often lack the nous and nose for the business and see their progression being determined by blind application of the rules.

My epiphany is that most organisations have semi-independent Rumeration Committees looking at the executive pay (they certainly can't self-govern that!) and Audit Committees (to check that they are not ignoring the independent(?) auditors) with a similar separation. Maybe we need to have the Risk element run the same way. While I am hesitant to make another committee, I do think that there needs to be separation and focus for the function, well away from those with the strongest P&L drive.

I doubt that the regulators can make that happen, but maybe the rise in shareholder power and dissatisfaction can. It seems ironic that while the finance industry, both investment banking and asset management is always ready to tell others how best to govern their enterpises they seem reluctant to do it to themselves - maybe major shareholders can?

PS If you are interested in this, standards or market structures do let me know and I can join you up with this initiative.