Contributor: Marcus Cree
In the regulatory reform book Regulating Wall Street: The Dodd-Frank Act and the New Architecture of Global Finance, by NYU Stern faculty, there is a focus on four pillars of an effective regulatory regime. The book maintains that a good regulatory framework should:
- Encourage innovation and efficiency
- Provide transparency
- Ensure safety and soundness
- Provide competitiveness with global markets
These pillars strike me as being exactly the same as those for an effective enterprise risk management system. In many ways, the role of the CRO is to be custodian of these central tenets. Taken in turn, senior risk professionals ought to be asking four key questions:
- Does the enterprise risk system actively contribute towards a culture of innovation? The system should be able to quickly handle new financial products and their attendant risk factors in such a way that their true impact on firm-wide market and credit risk can be swiftly assessed. Where this is not the case, institutions are left unable to either effectively compete in new markets or properly understand the added risks.
- Is the system transparent to all stakeholders? Regulators, senior management, and risk takers should all have sight of the risk topology and their place within it. This allows risk appetites to be set and monitored, and it creates a risk culture where there is a language that is common throughout the firm and part of standard communication within that firm. This, in many ways, is the overriding aim of the risk system.
- Does the system ensure the safety of the firm? This is far more difficult to quantify and should really be modified to ask whether the relative safety of the firm is ensured by the system. Risk taking is central to the business, but it is also a basic requirement that excessive risk taking can be quickly identified and that the risk profile is in line with risk appetite. In the current environment, external stakeholders, from equity and bond holders to counterparties and regulators, are looking for evidence of this.
- Does the system promote competitiveness? Heavily related to the first point, it is vital that risk takers can utilize the system strategically to understand and operate risk profiles within markets and with regards to new product decisions. The speed of arbitrage in the current world is such that it is very easy to be out of position from either a profit-making or a risk-taking perspective. The risk system needs to be a strategic tool, not an afterthought.
Global regulatory reforms are running at an incredible pace. At the same time, those reforms are based around systemic risk and safeguarding the system from individual failures. The same rigor is required internally, and it has to start with guiding principles. The four pillars identified in NYU Stern’s book are sound guiding principles and provide a great starting point on the way to robust and credible risk architecture.
While you’re here…
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