|Risk Appetite - need to 'ketchup' with|
From the Solvency II perspective, we know that (as it stands) Risk Appetite only exists in written word in Level 3 System of Governance and ORSA guidance, namely;
- That the AMSB is "ultimately responsible" for setting it (Sys Gov G15)
- That EIOPA did not wish to distinguish between "risk appetite" and "risk tolerance", rather let national regulators and the industry scrap out any divergence in term usage themselves (Sys Gov p30-38!)
- On that basis, "Risk Appetite" doesn't even feature in the L3 ORSA Guidance, though "risk tolerance limits" do (ORSA G7 and G11), perhaps indicating what terminology EIOPA prefer.
The ratings agencies expectations on Risk Appetite also come into play, with S&P expecting its "clear communication" and "linking to risk limits" as part of its ERM assessment programme (p5, and more extensively, p9). They do however have the courage to define their terms with respect to appetite, tolerance and preference in the appendix.
Appreciating therefore the Oliver Wyman paper is catering outside of the financial services sector, it still contains a host of rather inane platitudes such as;
Risk Appetite Framework
"...bringing discipline to major strategy decisions" - as opposed to the Chief Exec and Chair?
"...essential for firms considering an ambitious growth strategy" - as opposed to all firms?
"...developing a robust risk appetite framework does not take an inordinate amount of time and effort" - might want to tell that to the rest of the invoice-generating consultancy world!Risk Appetite Statement
"...more than just a set of benchmarks" - at what point has a RAS ever been that?
"...setting the 'tone at the top' about the relationship between risk and return" - "tone" as opposed to "rules"?It also contains a number of apocryphal tales and irritants, such as
- Senior management "often" fail to take risk appetite into account - probably true even in the financial services world pre-2007 (indeed it was a major feature of the Lehman's autopsy!), but one would think less so now.
- "Few" companies able to unlock benefits of a risk appetite framework - that feels a bit light, though I don't doubt some firms may struggle depending on their corporate structure and industry.
- Frequently interchanging between "Framework" and "Statement" throughout, in the same way as many ORSA-related materials do so for "Process" and "Report".
It ultimately recommends that a Risk Appetite Framework should contain the following characteristics;
- Qualitative and Quantitative Risk Appetite Statement
- Ensure the statement content is "useful" for all internal stakeholders (Board, Senior Management, Financial analysis teams and business unit leaders"
- Connect the statement to the planning, review and decision making processes and forums
There are also a number of positive elements within the document, which I would certainly advocate, such as;
- Size Limit - they recommend no more than 4 pages for a Risk Appetite Statement, and one could probably get away with less
- Concepts of Ability (what one can technically afford) and Willingness (to tolerate uncertainty)...
- ...applied as appropriate to a set of qualitative and quantitative themes which are pretty much ready off the shelf (p3)
- Ensuring the metrics used for monitoring are company-specific - very easy to replicate what one has seen in previous firms, but these will inevitably not make the cut in decision making processes, thus defeating the point.
I'll be doing more on this topic in the near future, but for now this material may at least be of use to you for benchmarking purposes.