2010 trends in risk management

Over the past eighteen months, we have all seen how events have altered the perception of risk management, both inside and outside an organization. Has increased scrutiny on risk managers translated into tangible changes to the way risk is currently being approached?

I’ve noticed three broad trends that have resulted from the exposure this area has had recently: vertical transparency, a strengthening of risk cultures and data control.

Post-crisis regulatory pressure on firms to prove the robustness of internal risk controls and the perceived failure of the credit rating agencies during the crisis are just two of the factors that have driven an increase in the number of chief risk officers. This is particularly important as investors are now demanding greater transparency to ensure that risk profiles are being properly monitored. Vertical transparency within the institution is therefore demanded since, as this external messaging is the responsibility of the board, the CRO requires clear bilateral communication between them.

It’s also been crucial to strengthen the risk culture right across an institution. Metrics produced by the risk management function need to be used in the decision-making process all across the trading floor. This is vital for two reasons. First, limits tend to be set centrally, with an enterprise view in mind, whereas a trader has local limits with little or no enterprise-wide visibility. The second reason is related to the efficiency of the calculations. Exposing the methods and data used as well as the outputs from the risk process allows traders to see that the correct parameters were employed. This removes objections to risk related decisions and further allows traders to understand the backdrop to the risk limitation process.

Finally, data control – long seen as the cornerstone of the risk management process – has now taken on an even greater level of importance. Recent market events have created a skewed set of correlated, downward sloping data that will take a while to work through the system. The effect of this is that close attention has to be paid to the input data for VaR and historical stress scenarios. Multiple data sets are likely to be needed in order to capture risks appropriate for both current and future states.

The emphasis on risk management has moved from increasing product complexity towards more fundamental concerns. This change of focus has gone a long way to helping ensure that there is no repeat show.