EIOPA's Bernadino with keynote speech - D'ohs and Don'ts...

Solvency II implementation
- Homer called it...

The latest pit stop on the Solvency II Last Legs tour was in the picturesque, almost-an-anagram, Slovenia, where EIOPA's gaffer joined a throng of hearty souls to deliver a keynote speech last week.

Given that the outside world is seemingly becoming more sensititve to the ensuing changes (at least from a capital adequacy perspective), it has been noticeable that EIOPA's speeches have become heavier in practical tone rather than the flabbier ethereal tones of yesteryear. In particular, conduct risks, conflicts of interest and the importance of an effective second pillar to counter the aggression and self interest of distribution arms/firms have all become prominent features of what is being touted as the Solvency II benefits package. Given what it has cost, we'd better deliver it!

Back to the speech, a few basic soundbites are littered throughout, which might benefit your training packs for the home stretch;

• Solvency II is "EIOPA's top priority", 
• It is a "pretty good starting point", rather than perfect, is "...a must and a true game changer", and "brings a new risk culture"
• It is "a tool to foster a true risk culture in the organisation"
• "It is clear that Solvency II will bring more awareness and transparency on the true risk profile of certain business models"
• It will deliver "intelligent and effective regulation which does not stifle innovation"

A couple of open-ended questions emerge from the text itself;

• Does Solvency II only "encourage" firms to define their risk profiles and risk appetites, as opposed to compel it?
• Is the Solvency II take on ORSA really "best practice at international level" - seems fair, but does anyone else want a shot at the title!
• Why is "overall solvency needs" constantly accompanied by bunny ears - if these guys aren't convinced by the term, what hope does the industry have of driving it into the glossary!
• Is it just executives who need to know that ORSA is a "cultural change", as opposed to NEDs, non C-suite senior management and wider stakeholders. Institutional investors would surely benefit a 101 class, given their demonstrable views on what SCR coverage ratios mean for the plausibility of some firm's strategies, and while Sr. Bernadino comments that "...effort needs to be made" to explain SCR volatility on p8, a dawn chorus with Karel van Hulle on how "ridiculous" the outside world's expectations are doesn't even qualify as an hors d'ouevre.
• That risk culture provides "...an appropriate balance with the natural sales driven culture" - EIOPA have alluded to this before, but never quite as explicitly as this. If the Risk function's job is predominantly to counter sales activity, can it ever be seen as value adding?

And a couple of specific themes are given special treatment for everyone's benefit;

Prudent Person Principle and the investment strategy of insurers

• PPP emphasised as not giving insurers a freebie to hit the roulette tables with their asset book, and will be "...closely monitored".
• Current environment encourages aggressive monitoring, with the "search for yield" quote now ubiquitous in supervisory speeches which touch on macro matters.
• "Asset risk calibration in Solvency II should not be used to privilege or incentive any specific asset class" - not convinced on this front, given the remit of your friendly local CIO must contain an element of maximising gains within appetite, and the calibration can surely influence that.

Product availability

• "Solvency II does not intend to unduly penalise specific products" - evidently does though, hence the sprint to the door from Ergo et al in the guaranteed interest rate product space (not unduly though to be fair, given the Teutonic pleas for transitional mercy!)

ORSA and Risk Culture

• The section somewhat labours the point on coverage of all risks, assessment of all mitigation techniques, and the role of the Board in driving the associated cultural changes, but I guess given the geographical location of the speech, some of the nearby countries may benefit from the encore un foi approach - no names naturally...
• "Capital will never cover up for the lack of proper governance"
• "ORSA is based on the companies' DNA - their strategy"
• "The key role in the implementation of ORSA belongs to the top management"
• "It is up to the Boards to set, communicate and enforce a strong risk culture..."

Insurers and Supervisors in general

• Talks of Risk Functions needing the correct skills to assess risks in asset classes - is there an implication here that functions will be light on quantitative skills post-2016?
• Squares the circle of prudential and conduct risks on p7, talking of mitigating conduct risks "since inception" in one's product development, design and marketing processes.
• That Solvency II "...requires an increased degree of supervisory judgement" in order to intervene at the right time, and the new supervisory requirements represent "...an upgrade in the quality of supervision". I'm sure some countries might take that as something of a slight, given the maturity of their existing processes, but probably fair for the majority.

Plenty of fuel for your respective Board and Senior Management briefing fires, so go forth and propogate!

PRA Final Notice on Co-op Bank - "cautious", with blurry lines...

"Two straws please"...

The PRA published a Final Notice last week regarding the numerous shortcomings of a UK bank over the last few years, which included the news of a colossal £121m fine which the PRA would have levied if the entity wasn't still losing wedge faster than a mojito in a cement mixer.

I'm sure some of us chortled at the Chrystal Methodist headlines a couple of years ago when the Non-Executive Chair of the UK's Co-operative Bank had his numerous vices sold to the highest tabloid bidder by a rented acquaintance. I covered some of the initial fallout on here, themed mostly around reputational risk and fit and proper persons, given the exponential effects of the exposé on the ultimate failure of the Group in its form at the time.

A document covering part of Co-op's demise, specifically its Bank, was released last week by the PRA,

The PRA's Final Notice to the Co-op Bank is issued publicly, and highlights where the firm breached what were at the time the FSA's Principles for Business, replaced since the PRA/FCA divorce by the PRA's Fundamental Rules.

Included in the Final Notice on this matter was a number of matters which risk practitioners should be salivating over, given the failures which led to this punishment include

• Inappropriate culture,
• Internal control framework failures,
• Ineffective risk management policies, and, the jackpot,
• A "three lines of defence" model "...flawed in both design and operation"!

The activities demonstrating this include a woeful suite of incomplete management information, three horrendously chancy accounting interpretations benefiting the balance sheet at the expense of real-world accuracy, and a suite of defensive line failures, all of which are followed through in forensic detail.

I have sectioned my notes below for my own use, particularly given the PRA goes on something of a limb here and provide usable definitions for certain terms which I suspect many practitioners would benefit from reading. The PRA (and EIOPA) generally try to dodge requests for definitions, so while the peg is square and the hole is round, it might be as good as you get!

Definitions and expressions

• Three lines of defence - "This is a system which relies on there being an opportunity at three complementary and independent levels to identify and correct any control failures". 
• Second line of defence - "Second line functions should support and challenge the management of risks firm-wide, by expressing views within a firm on the appropriateness of the level of risks being run"
• The above is supplemented by the following: "Responsibility for risk should not be delegated to risk management and control functions" - amen brother!
• Third line of defence - "Internal Audit should provide independent assurance over firms' internal controls, risk management and governance"
• Risk Appetite - "A firm's stated risk appetite is an important factor in determining whether a firm's risk and control framework is commensurate with [the] nature of its business, and should be both integral to a firm's strategy and at the heart of its risk management system" - not far off a direct quote from last year's Approach Paper on Banking Supervision (p22), though it has moved from "foundation" to "heart" in this Final Notice. I know what I prefer to build on!
• "Clearly-defined strategy" - they list "well-defined objectives, responsibilities and milestones" as expected
• Policies - "The establishment of appropriate policies [and procedures] governing the conduct of a firm's activities is an essential component in the exercise of appropriate organisation and control of a firm's business"
• "Good risk management culture" (p7) - interestingly an expression most bodies have avoided using, preferring "sound" to "good". They later go on to talk of culture more generically in terms of "right" and "inappropriate" (p33).

Observations

• Interestingly, Co-op Bank never refer to operating "3LOD" until their 2012 Annual Report (p56 for the boilerplate and clearly untrue definitions), so any deficiencies in the model before that year might be for a good reason!
• First line management oversight was seen as "inadequate" and "inappropriate" (p12)
• Their second line managers "...repeatedly voiced concerns" about headcount (p29), which weren't addressed until the back end of the period under scrutiny. Hard to think post-2007 it would be hard to justify reinforcing that area of the business, which perhaps says a lot about the entity's culture. 
• Second line not monitoring adherence to policies (p29) - quite hard to conceive of nobody in the second line doing this!
• A clear distinction made more than once between "Risk Management Framework Policies" and "adequate policies and procedures" relating to operational matters (p5)
• Some of the failure to follow 'internal policies' seems to have been sponsored by the acquisition of the Britannia book - perhaps a natural by-product of M&A activity, where the cultures and modus operandi clash (p21)
• Second line criticised for not providing proper "independent challenge" - happy to see this, given the focus tends to be on second line oversight, which always feels like a bit of a jib-job.
• Third line giving the business credit for proposed remedial action in its audit reports (p31) - even taking this into account, they were rolling over around 30% of recommended actions in their reports as "overdue"!
• Head of Internal Audit reported to the Head of Risk
• An implication that one may be permitted shortcomings in one's internal control framework, providing one's culture is "appropriate" (p5). 
• An interesting slant on reputational risk emerges from one of the accounting interpretations used, specifically that while assuming a particular accounting treatment (on the Leek notes in this case) which benefits the entity at the expense of counterparty might benefit the immediate balance sheet, the long-term effect on being able to raise new capital must be considered (p16)
• External Auditors using a 1-to-7 scale to assess how punitive/liberal the accounting treatments used by clients are. These assessments have bitten this particular client on the bum, given the PRA quote them in the document in the context of whether they align with a "cautious" risk taker!

Open ended questions

• Is "cautious" a realistic appetite for risk at Entity level? More importantly, if one has a "cautious" risk appetite, is one obliged to manage its capital "cautiously"?
• Management information was criticised for not being "sufficiently forward looking" - should it be (as opposed to mostly summarising positions at a point in time)?
• Is the PRA allocating resources to firms based on their Risk Appetite Statements (p13)?
• Is it possible for non-Accounting experts working in the second line to identify just how many ropey interpretations of UK GAAP/IFRS are being applied to a balance sheet? Is it plausible to leave such work to external audit firms who couldn't have a more vested interest in the grey areas of such legislation? The artificial boosting of the balance sheet listed in this notice would be subtle enough to trick an accountant or two I'd bet!
• Can quant risks be effectively managed in a separate team from the qualitative world? Appreciating there is a shockingly blurry line in Co-op Bank's approach (p29), it certainly feels like Solvency II pressures might lead to similar pressures on the staffing front, particularly for modellers and small/medium sized firms where staff may wear more than one hat.

CRO Forum on Risk Culture - comin' from the body heat?

Risk Culture
- need another hero?

A subject which is gathering more steam than Tina Turner's windows, Risk Culture has been given the kid gloves treatment by the CRO Forum in their paper, Sound Risk Culture in the Insurance Industry.

They say at the start that the topic has become "prominent in regulatory circles", which given EIOPA appear to be wining and dining the subject (here and here in the last couple of weeks alone), is something of an understatement. Their increased interest has no doubt been fuelled by the FSB's work on the subject from a year ago. In addition, the Financial Reporting Council took a shine to the topic in its last update of guidelines in late 2014 (point 27 in particular), while cultural failings have turned the FCA into a modern day Robin Hood (speech from inception time here).

As well as fiddling around the edges of definition, the paper expands on a few examples of where cultural change can be driven from, stealing from a few other industries (aviation in particular) and a couple of insurers (Zurich receiving particular attention).

They fundamental base they work from is pretty fair:

• No "good" or "bad" culture, hence they talk about practices that encourage a "sound" risk culture throughout. Given that ropey culture does not necessarily prevent the achievement of strategic goals, this smart.
• No "one-size-fits-all" concept of Risk Culture (i.e. don't look for one in this paper!)

That said, the definition used for the purposes of the paper from the NN Group CRO is actually a pretty good one - "shared philosophy of managing uncertainty" etc - though it does suggest that a failure in risk culture might simply be someone not sharing the philosophy, which I suspect is where a lot of your more pragmatic colleagues sit!

There are a number of sound inclusions throughout;

• Emphasising the links between risk culture and conduct risk currently being force-fed to the industry by EIOPA (p3)
• The chart on p6 showing survey results of essential elements of risk culture - senior management and Boards leading by example is evidently seen as more important than risk-based remuneration, despite the legislative attention the latter receives (including this week in the UK).
• Zurich's internal 10 question survey on culture assessment - contains the gorgeous expression "organisational humility", as well as bringing some of the granular risk culture elements onto the table, such as treatment of whistleblowers.
• Highlighting the "common phenomenon" of management teams containing people with the same personal attitudes - could benefit the creation of a "shared philosophy" without necessarily any of the benefits.
• The illustration of NN Group's "Risk Culture Dashboard" (p11) - I don't have preference for it either way, but it does illustrate how much effort one can direct towards risk cultural identification, assessment and monitoring, which begs the question "is there that much value in it?" They seem to like it as a way of covenying the concept in the business in any case.
• Pages 13-14 provide some good brain candy for those who have ambitions to educate or brief their colleagues on risk cultural matters. Zurich's "we are all risk managers" campaign looks like it probably has legs (more on it here).

There are a couple of mildly objectionable parts within;

• Concepts of "Risk Vision" and "holistic" dropped in early doors and littered throughout, as well as a few extras such as "risk perspective" - the kind of obtuse terminologies which serve to divorce Risk functions from their colleagues
• That firms should have a "clear vision" for their risk culture - why would something as opaque as culture be expected to be "clear". They don't even define it as a term in the paper!
• Concerned that risk culture is "...only practiced by risk specialists" currently - how can this be if risk culture is "...an element that influences and is influence by various forces"?
• Tha an organisation's corporate culture and risk culture "must be linked" - how are they not one and the same thing?
• That Risk Appetite Statements are "effectively part of the business strategy" - as opposed to "actually"?
• Use of the term Risk Profile as if it is unquantifiable, specifically that a firms who learn from their mistakes rather than chastise those who make them "tend to have a better risk profile". Not clever.

EIOPA Chair's speech in Ireland - Nothing Compares to U2...

The huff has concluded it would appear – EIOPA’s gaffer has returned to the speaking circuit after a few weeks where the institution’s communications had been reduced to Post-It notes on the fridge after the EU butchered their budget.

Bernadino - dodgy stand-up

 

A recent Solvency II industry event was held in sunny Dublin, with Sr. Bernadino providing the keynote address. He chose to start and conclude with U2 jokes, which were as lame as a constipated flamingo (I would have thought Ben Folds Five or Lulu would be top of his playlist right now…)

That aside, the meat in this musical sandwich was pertinent to the whole industry, so I've picked out a few highlights;

General

• Wants to outline EIOPA’s move “from regulation to supervision” (p2), though goes on to say that “…EIOPA does not replace NSAs. The responsibility of the day-to-day supervision…rests with the NSAs” (p10). I think this subject warrants clarification from NSAs and EIOPA in concert, given we can see how having a remit-less overseer is putting the PRA on the back foot
• Acknowledges that the result of the mathematical squabbles is “…perhaps a too complex SCR formulation” (p3)

ORSA

• ORSA considered to be “…best practice at international level” (p4) – not sure if he means ORSA in general IAIS terms, or the ORSA concept he has curated within the EU!
• While he drops some of the usual ORSA bluster in about it being a “game changer”, he beefs up on the Board’s obligations, citing their "fundamental role to play", and stating in particular that "they need to set, communicate and enforce a risk culture".
• Of particular significance to his Irish audience was his emphasis on risk culture as "..an appropriate balance with the natural sales driven culture". This is perhaps the first instance where I have seen insurers' distribution arms formally considered by a supervisory body to be the enemy of 'risk culture', and for EIOPA's chair to choose Ireland, a country which has for years marketed itself as a cross-border sales centre on the right side of General Good provisions, is shown at the end speech to be a pre-emptive strike.

Internal Models

• Like his associates at the PRA, he notes that the use of internal models on the banking side "has been subject to increasing scepticism" in justifying the rigour of the Solvency II approach to modelling
• Worried that models will become a "capital optimization tool" - the PRA's NED briefing (slide 8) paints a similar picture if you read between the lines regarding missing risks and experience not reflected in parameter setting.

EIOPA's workload

• "Current different supervisory cultures" in the EU are creating work for EIOPA, noting that "our feedback can sometimes be challenging". Wonder who they're getting at there, France!
• They appear to be developing a Supervisory Handbook of good Solvency II practices. Chapters are already written on Risk Assessment, Boards and Governance, PPP and proportionality in Key Functions to name a few. Something to look forward to no doubt

Ireland-specific

• Go out of their way to applaud the onerous reserving governance in Ireland (here?), considering it practice which other countries should emulate.
• On the other hand, "...in the specific case of the Irish insurance market" he targets the country from a conduct risk/General Good perspective as one of the main cross-border players in the Union.

One can't help but feel the latter part of the speech was deliberately laid at the feet of the Irish, rather than aired in a more generic manner, given the country's continued corporation tax-related appeal to cross-border distributors. I guess when it comes to identifying the perfect audience to sketch out EIOPA's inevitable foray into Conduct Risk regulation, Sr. Bernadino found what he was looking for...

FRC on Risk Management and Internal Control disclosure - insurers way ahead?

Muddy Waters
- public disclosure on Risk

The UK's Financial Reporting Council have released guidance on Risk Management, Internal Control and related reporting, just in time to help muddy the waters for UK insurers, who have no doubt finally got their risk, actuarial and compliance functions writing non-conflicting words with Solvency II preparation in mind!

Anyone who has written, peer-reviewed or socially read these sections of public reports (i.e. me, and any other geeks), will know they are normally;

• Boiler-plate, and completely transferrable between industries, regardless of their disparate risk profiles
• Aligned to the Strategy sections with a few anchor words, but otherwise divorced
• Frequently unaligned with the ERM frameworks used internally - i.e. "this is what the City wants to read", not material on our actual risk profile!

Given that this is only guidance, and is further only directly relevant to LSE listed entities, readers may be inclined to take the content with a fistful of salt. There are a number of noteworthy aspects to this publication however which maybe show where the mindset of supervisory-types has got to in the eight or so years since the financial crisis commenced.

 I took the following general points from it;

• Very little for listed insurers to be concerned about, if they have prepared adequately for ORSA and supervisory reporting (SFCR, RSR) - indeed, their reporting teams will be delighted with the amount of content crossover! Check out the (still not finalised) Delegated Acts of Solvency II in order to see why listed Insurers won't need to stretch to meet these.
• Frequent references to "culture", as opposed to "risk culture". Checking the FSB's take on Risk Culture from April of this year, one can appreciate the FRC's desire to gemmy culture into these guidelines, if perhaps not the execution - one fears the "culture" words are likely to become a little weasely.
• Multiple crossovers into ORSA language, in particular re-emphasising the importance of the alignment of risk management with business strategy.
• Good work in section 4, bringing in the "IMMMR" concept from Solvency II, as well as assessment of current and emerging risks, and assessing exogenous and endogenous risks when doing so.
• Recommend that risk assessments are performed at inherent and residual level, and that control effectiveness is also considered when arriving at one's final assessment

On the technical front, the following elements caught my eye

• "Emerging principal risks" used as an expression - not sure if that stands up to scrutiny i.e. if something is emerging, can it be a "principal" anything? How would you measure it to gauge "principality"?
• Reference to "high profile failures in risk management" in recent years, which feels a little finger-pointy - we could deconstruct every corporate failure to one of risk management failure
• "Risk Appetite" put into inverted commas within the guidance, but not in the appendices - can't quite work out the aversion to definition given the FSB's work to date at the very least, but certainly EIOPA have similarly dodged it (p59), and looking at Appendix 1 of the Irish regulator's thought paper on Risk Appetite, one can see why!
• "It is the role of management to implement and take day-to-day responsibility for board policies on risk management and internal control" - really? responsibility for their implementation, sure, but policy content?

Financial Stability Board - Principles for an Effective Risk Appetite

Christmas has come early everyone - the Financial Stability Board have released their Principles for an Effective Risk Appetite Framework today, and I'm greedily ripping in to it before JC's birthday like a spoilt, yet handsome child...

FSB's RAF Principles published- 

send the car back lads...

There has been a reasonable amount of traffic on Risk Appetite this year (here, here and here for a start), after the FSB but announced their consultation earlier in the year, I've been on tenterhooks. This was following of the back of a thematic review on Risk Governance as a whole by the FSB, which they published back in February.

So where do they take this deep dive into Risk Appetite? Other than awkwardly shoehorning in the soup de jour of "SIFIs", they stick to the hard areas which will get every risk practitioners' attention (namely, Risk Appetite Framework, Risk Appetite Statements, Risk Limits and Roles and Responsibilities), though "for clarity and simplicity", they jettison the use of Risk Tolerance. Definitions are supplied on p2-3, which you may find useful as anchor references.

They somehow make room for anodyne flannel in this very short document, for example;

Risk Appetite Frameworks

• Should "facilitate embedding risk appetite into the financial institution’s risk culture" 
• Development and establishment is an "...iterative and evolutionary process that requires ongoing dialogue throughout the financial institution to attain buy-in across the organisation" (groan)

Risk Appetite Statements

• "Risk appetite may not necessarily be expressed in a single document; however, the way it is expressed and the manner in which multiple documents form a “coherent whole” need to be carefully reviewed to ensure that the board obtains a holistic, but compact and easy to absorb, view of the financial institution’s risk appetite"

Risk Limits

• "Having risk limits that are measurable can prevent a financial institution from unknowingly exceeding its risk capacity as market conditions change and be an effective defence against excessive risk-taking" - tell that to Lehmans!

However, the salient points for me were as follows;

Risk Appetite Frameworks

• RAF "...sets the financial institution’s risk profile" - not convinced on that one, but may be semantic issue
• "explicitly defines the boundaries within which management is expected to operate when pursuing the institution’s business strategy"
• Should "be adaptable to changing business and market conditions" to allow for limit increases where appropriate

Risk Appetite Statements

• "[should] address the institution’s material risks under both normal and stressed market and macroeconomic conditions"
• "...should establish quantitative measures of loss or negative outcomes that can be aggregated and disaggregated"
• "...include key background information and assumptions"
• "...include quantitative measures that can be translated into risk limits"
• "...be forward looking and, where applicable, subject to scenario and stress testing"

Risk Limits

• "[should] be set at a level to constrain risk-taking within risk appetite"
• "...should not be strictly based on comparison to peers or default to regulatory limits"
• "[should] not be overly complicated, ambiguous, or subjective"

Roles and Responsibilities

The Board

• ...must establish the institution-wide RAF and approve the risk appetite statement, which is developed in collaboration with the chief executive officer (CEO), chief risk officer (CRO) and chief financial officer (CFO)
• FSB specifically comment that Boards who "receive" or "note" Risk Appetite Statements have a lower understanding of risk appetite (so don't sponsor it!)
• " [should] regularly review and monitor the actual risk profile and risk limits against the agreed levels (e.g. by business line, legal entity, product, risk category), "including qualitative measures of conduct risk"
• " [should] ensure risk management is supported by adequate and robust IT and MIS to 
• enable identification, measurement, assessment and reporting of risk in a timely 
• and accurate manner."

CEO should

• "...be accountable, together with the CRO, CFO, and business lines for the integrity of the RAF"
• "...ensure that the institution-wide risk appetite statement is implemented by senior management"
• "...provide leadership in communicating risk appetite to internal and external stakeholders" 
• "...establish a policy for notifying the board and the supervisor of serious breaches of risk limits and unexpected material risk exposures"

While there are specific sections for the obligations of CRO, CFO, Internal Audit and Business Unit Management, they don't necessarily expand much further than what I consider to be normal functional expectations, so I haven't elaborated on them.

One should certainly therefore expect a much more aggressive approach from supervisors in future off the back of this - combing through strategy and board papers for evidence of Risk Appetite in application, and making sure that Risk Appetite Statements are not just 'rubber stamped', for example.

I certainly don't see much in this for stakeholders. Nothing particularly new is brought to the table here, and if this is the results of peer review and shared experiences, then clearly there is concurrence on how an RAF should be constructed, what a RAS looks like, and who should do what in regard to continuous monitoring.

The skill will be for risk practitioners to convince their CEOs/NEDs that, this is no longer a sidecar activity in the ERM best practice space, but a nascent global minimum standard which will invariably surface in national regulations in the forthcoming moths and years.

Aon Risk Maturity Index Report 2013

With the potential for early implementation of Pillar 2 on the horizon for Europe's insurers, Aon's release of their latest research on Risk Maturity Index is perhaps a timely one, particularly for anyone in the small-to-midsize bracket who wants to get a feel for the proportionality of their current approach (and for UK IMAP candidates, whether it might fold under ICA+ questioning in the next two years!)

Their claim that that the Risk Management Index fills the current "void" which prevents interested parties from benchmarking their risk management frameworks against those of their peers, and indeed reaching recommendations on how to further enhance them has a whiff of bolshiness about it, but nevertheless, the output is valid for practitioners in all industries.

Fundamentals behind the research, conducted in conjunction with Wharton Business School, are;

• Aon's "Risk Maturity Index" is an online self assessment of risk management practices.
• It asks 125 questions regarding 40 "key components" of risk management - all tied in to the following 10 characteristics of risk maturity:

 1. Board Understanding & Commitment to Risk Management

 2. Executive Level Risk Management Stewardship

 3. Risk Communication

 4. Risk Culture: Engagement & Accountability

 5. Risk Identification

 6. Stakeholder Participation in Risk Management

 7. Risk Information & Decision Making Processes

 8. Integrating Risk Management & Human Capital Processes

 9. Risk Analysis & Quantification to Understand Risk & Demonstrate Value

10.Risk Management Focus on Value Creation

• Allows for a ranking between 1-5 across various sub-cuts of the data collected, and an assessment in aggregate of each firms "risk maturity"
• Data was then analysed against over 100 listed companies from 20 industries, geographically spread, to see if "risk maturity", or a lack of it, translated into anything measurable
• Over 500 companies have responded to the survey since 2011, this being its second periodic summarisation (results from first one summarised here).

The headline news was that a correlation was identified between organisations with superior risk maturity and stock price volatility, with a reduction of up to 50% potentially up for grabs between the 'best' and the 'worst' - a particularly visceral way to "derive and demonstrate financial value from...risk management frameworks" which, let's face it, is a hard sell for the best of us!

I observed some more general points from the white paper, namely;

• The insurance industry was third only to Aviation and Consumer Goods in the assessment of risk maturity - something to be learnt from these industries (in particular around Op Risk maturity in Aviation)?
• Only 15% of respondents were rated at 4+ out of 5, or "operational/advanced" in Aon's terminology
• Lower revenues seem to translate into lower risk maturity on the whole
• Responses from CRO's resulted in the best aggregate maturity scores, while Internal Auditor/CFO responses resulted in the worst aggregates - expected biases nicely exhibited

Of particular note though were the three areas of common differentiation between higher and lower rated firms which are worthy of more attention than might otherwise come from reviewing average maturity scores. 

Awareness of the complexity of risk - more mature organisations are able to demonstrate:

• Risk adjusted return expectations by business unit/department
• Documented and applied assumptions in forecasts/projections
• Supporting forecasting ranges with applicable historical data

Agreement on [risk] strategy and action - more mature organisations stabilise their performance by:

• Re-evaluating risk management strategy based on experience
• Reviewing and validating risk tolerances based on external conditions
• Evaluating strategic decisions with reference to quantified risk tolerances

Alignment to execute [the risk strategy]

• Communicating negative results and predictions (nicely tied into Risk Culture by Aon)
• Developing cross-functional risk understanding, and how organisational activity relates to overall risk management strategy 
• Incorporating risk/return approaches into strategy, in particular recognising up-side potential in decision making, rather than loss minimisation

These are particularly interesting findings for the EU insurance industry, who will be waddling into Live ORSA territory in the coming weeks and months. Fair to say that Solvency II Pillar II accommodates much of what is covered here, so worth thinking about leveraging this benchmarking work in one's 2013 activities.

Elderfield speech to Institute of Directors in Ireland - 'the Gene Genie'

With all the subtlety of an American industrialist in Paris, Mr. Elderfield delivered a speech to the Irish IoD this week focused on the Central Bank of Ireland's refresh of its 3-year strategic plan, as well as reinforcing what it expects financial services Boards to be focusing on in the near future.

This of course should sit in the context of what I covered last week on thematic enforcement work in 2013. Aside from his comments around board diversity, namely that the CBoI's 'fit and proper' activity to date is "...broadening the gene pool of corporate life" (eeeewwwww!), emphasis was given  to three particular areas:

Risk Appetite Statements

• CBoI expects "... [a] high quality risk appetite statement that is well understood and implemented throughout the firm in practice"
• "...clear articulation of the acceptable level of risk...at different confidence levels, is an important discipline and an essential compliment to a well-articulated business strategy"
• That, due to disappointments in the past, Risk Appetite statements are "...certainly an area of increasing interest on [the regulator's] part, and where we are debating the best approach for encouraging improvements"

System of Governance and Risk Culture

• Boards should "...provide broad, challenging scrutiny of your firm's culture regarding regulatory compliance and internal challenge"
• Ensure that there are "...appropriately resourced and well-qualified risk management and compliance functions"
• "Think more fundamentally and strategically about the culture in the institution that you oversee"

I would add that a lot of this sits nicely with the FSB's Risk Governance paper which was released last week.

Board composition

• Expect directors to take a "...hard nosed view on Board composition, with a view to improving performance"
• Endeavour to attain the "...right gender diversity...and international experience"

With Risk Appetite and Risk Culture both having featured on the IRM's hitlist recently, the practitioners over there will have some assistance to hand from an industry body, however there should be some other useful stuff available in the tag cloud at the bottom of this page on appetite, culture and diversity if you are struggling for inspiration.

Financial Stability Board - Thematic review and recommendation on risk governance

The Financial Stability Board (FSB) have been sticky-beaking around systematically important financial institutions (SIFIs) with a relative unchecked remit ever since the financial crisis first reared its head. This week they have emerged with a very significant document for Risk practitioners across the globe, with a thematic review of Risk Governance (press release also available here). The participants were 36 banking and broker/dealer institutions of interest, as well as major supervisory bodies and NGOs.

On the basis that there isn't a single accepted global standard on the matter, the thematic review compares prevailing practices against an amalgamation of content from exising standards from the IAIS, OECD and other bodies. Of major interest to risk practitioners is the document's focus on areas which the IRM have covered recently, namely risk appetite/tolerance/limts/capacity and risk culture.

Bearing in mind the great and good from the prudential regulatory world are active participants in the FSB, the likelihood of their findings emerging in the regulatory principles of tomorrow are pretty high. Of course this research has been based on Non-Insurance SIFIs, and so insurers large and small who have been endeavouring to meet Solvency II Pillar II requirements will find themselves in a decent spot already.

On that basis, I noted the following;

General recommendations to supervisory bodies (p4)

1. Formal requirements on the independence and skillsets of Boards
2. Hold Boards directly accountable for risk governance, and whether or not their existing suite of risk MI is sufficient
3. Formally elevate the stature, authority and independence of the CRO role
4. Require an independent assessment of the effectiveness of the risk governance framework to be performed on an annual basis (a list of what Internal Audit would generally review in this context follows on page 24)
5. Engage "more frequently" with Boards and management to assess risk culture

Sound practices list p30-34 - highlighted below are elements which may be new to the UK in particular, were they to be introduced

• Boards - annual reviews of member qualifications, skills and time commitments; meet quarterly with regulators; "effectively inculcate" an appropriate risk culture
• Risk Committee - annual approval of risk management policies
• Risk Management function - CRO to have direct reporting lines to Board/Risk Committee as well as CEO; public disclosure of CRO firing/hiring; be "actively involved" in strategic decision making processes; meet quarterly with supervisors; stress testing "on demand" at the behest of the business

Risk culture and risk governance supervisory assessment

• Notes that supervisors need to strengthen their ability to assess a firm's risk governance "...and more specifically its risk culture"
• "More work is needed" on regulatory assessment of risk appetite frameworks
• "Risk culture plays a critical role in ensuring effective risk governance practices through changing environments"
• FSB have a working group exploring the potential for formal risk culture assessments, who are  reporting in September 2013

Risk management functions and CROs

• Acknowledges that there have been "[raised] supervisory expectations for the risk management function" since the financial crisis
• Highlights that "most firms note that the CRO has a direct reporting line to the CEO", though "access to the Board" apparently remains more of an expression than a vivid reality
• "Good progress" has been made on enhancing the stature, authority, and independence of the CRO position
• Rather non-descript comment that "the Chief Risk Officer and the risk management function are responsible for the firm's risk management across the entire organisation" - responsible for what element, not conduct surely?

Risk appetite/tolerance/limts/capacity

• Acknowledge a "lack of common terminology for risk appetite, risk profile and risk capacity...within firms, across firms and across national authorities"
• Definitions of appetite and capacity used by FSB largely line up with IRM's definitions (though the IRM use 'tolerance' rather than 'capacity')
• "Key features of a Risk Appetite Framework" are listed on p22 - however even those firms considered best in breed commented that there are ongoing "operationalising" problems with RAF rollout
• Suggest that breaches of 'risk limits' should lead to reductions in exposures (piii) - not sure why the alternative of increasing appetite is not acknowledged

Institute of Risk Management on Risk Culture - ABCs, Double S's and mercenaries

So I figured it might be worth seeing how the other half were living by reading something that didn't start with "Solvency II" and end with "indefinite delay"!

The IRM are endeavouring to produce white papers on some of the less tangible elements of a risk practitioner's day job, which one would hope contribute to more consistency in practitioner approaches and ultimately more credence in the concept of risk professionalism (indeed, their work around defending pure risk professionalism as a career, as opposed to loading risk functions with cross-over actuaries, was very much required in early 2011).

Having scrutinised their work on Risk Appetite in 2011 (lined up against some of the competing influencing bodies here), I figured it was only fair to take a punt at their new release on Risk Culture. It's fair to say that for politicians, regulators and fingers-caught-in-the-till employees, 'culture' or 'risk culture' appears to be a handy soundbite when explaining why they didn't fulfil their obligations to their stakeholders. The IRM are joined by Protiviti in producing this guidance, Protiviti themselves having delivered a survey based on UK insurers on this very topic in the summer, which was not shy about highlighting how little some organisations think of their Risk functions.

I've always felt that the 'culture' comfort blanket was one weasel word too many i.e. "there was a culture of greed" = "they were greedy ********", or "there was a culture of fear" = "scared of the gaffer", so I approached this doc with a pretty open mind, but tempered with a Manxman's natural scepticism. I found the following (sequentially);

What does a good risk culture look like?

• Appears to have used examples of what a "bad" risk culture has recently led to, then flipped that on its head! Would have thought a clean slate approach is better for white papers, rather than reacting to zeitgeist incidents
• Fair list of 10 criteria for anyone in the risk culture assessment space, though will always be a nightmare to codify/quantify.
• The appearance of the dreaded "tone from the top" suggestion, which makes an appearance in the FRC's (p4), the FSA's and EIOPA's world (p10) - bearing in mind that the "top" is normally the problem when it comes to organisational catastrophe (Lehman, Northern Rock) as opposed to fat tail op risk loss events UBS/Credit Agricole/JP Morgan), I would be more inclined to call it "tone at the top".

What does risk culture mean?

• I like the IRM's take on culture being "the repeated behaviour" of a group - very convincing definition in comparison to say the FSA in SYSC (p12), though the rest of the ABC approach is a tad woolly.
• "Virtuous" versus "vicious" cycle sits nicely alongside this image of repetition, but nothing as such around how best to break a vicious one, either as a NED or a Head of Risk - perhaps that has been saved for the more extensive and expensive practitioner's guide!

Why is risk culture important?

• Don't agree that risk culture affects the capability to take strategic decisions, rather it enhances or impairs the quality of those decisions. Immediately makes me think of ORSA, and how "playing" at it or "doing" it doesn't prevent strategic decisions from being made.
• Also don't agree that "at worst" an inappropriate risk culture could lead to "serious reputational and financial damage" - I'm sure stockholders at Bear Stearns may say it can be a bit graver than that!
• Nice emphasis on how risk culture can both stifle necessary risk-seeking behaviour at one extreme (smartly citing Eastman Kodak as a "too slow" corporate failure), as well as the more obvious "prison rules" which emerge from uncontrolled risk taking.

What can the board do?

• Should they really ask themselves "what is the current risk culture"? If so, is that at a chinwag-type round table, or via some kind of evaluation survey issued by Risk function? Instinctively sounds like the kind of thing that would be squeezed into a Q1/Q3 board meeting at the point of a gun, which is as cynical as it is sad!

Understanding risk culture in an organisation

• The meatier (i.e. costs money!) practitioner guide apparently contains some diagnostic tools to effectively indicate and track culture within an organisation. The flash we are given here reminds me of the psychometric testing for "what makes a great Risk Manager" that I looked at last year, but feels ultimately very high-end.
• The "Double S" model is an intriguing addition to the mix, specifically the comment that low scores on either rating "create a barrier to the effective management of risk". Would love to see more of the research cited, as I've found that the odd mercenary firm can work wonders...

Changing a risk culture

• Can a risk culture effectively be changed top-down without a change in personnel? Can't imagine an existing CEO being prepared to antagonise his board/exec team by declaring them culturally bankrupt unless he had carte blanche to do so, which is normally the case with regime change. I'm more inclined to think a decent CEO, partnered with Risk, could do it by stealth, rather than with a pricey change management programme which would inevitably rock a few boats.
• "Risk culture is not a precise science" - does that make it an art?

10 questions a Board should ask itself

• I would probably make it 11 questions, and frame the first one "Do we genuinely care about how culture impacts on our decision making, or only insofar as laws and regulations insist upon it?". If a Risk practitioner gets the answer to that directly from the Board/Exec, the other questions can be catered for with proportional vigour.

Thought provoking in the right ways, I guess it does what a good white-paper should - thanks to all concerned at the Institute.

Institute of Risk Management - presentations on Risk Culture and embedding risk management

Delivered last week at the Solvency II Special Interest Group were a couple of presentations regarding embedding risk management and "risk culture". I generally think that "culture" is something you find in a yoghurt pot, but to be fair there is some good stuff in the materials below;

IRM Chair's presentation - some nice elements in this, such as

• Risk culture being "at its simplest...how 'risk management' is factored into decision making" - I would go further and make this the most complex definition, rather than elaborate
• Nice transposed diagrams of how certain risk cultures need to implement ERM in certain ways

Survey on risk culture and embedding risk management - remember at 28 participants it is a small sample, but flags the following;

• Around half are lumping "risk culture" and "embedding risk management" into their (Risk?) Solvency II Workstream (i.e weren't planning for it otherwise)
• Quarter had no sponsor for risk culture work
• Around 30% cited "lack of access to management time" as a challenge
• No real favoured technique for assessing risk cultures or embedding risk management - number of options cited
• None of the 9 relevant participants had received a "poor" rating from S&P for their ERM structure
• Not many outliers on the questions regarding risk governance, risk resources, risk transparency and responding to bad news - most were 2/3 out of 4
• Few more outliers in questions on risk competence, making risk decisions and rewarding risk taking - suggests that, while companies are relatively competent at 'playing at doing risk', at the sharp end the relevant skills and attributes are by no means compulsory

Not exactly my cup of tea this subject, but this is still useful stuff.