Friday, April 30, 2010

Risky Business!

At the end of a week full of news on the Oil Spill, Volcano Ash and Greek debt fallout in Europe, York University organized a symposium on Risky Business. Talk about timing. The unique format brought together academics and industry experts.

Howard Adelman, drawing on his experience of early warning systems for genocide and war, argued for building similar systems in the financial industry, though few actual details of such a system emerged during the presentation or discussion. A key question was whether socio-economic systems are now so complex that early warning systems are too difficult to create. Adelman’s overall position, drawing on a historical and philosophical perspective, was that innovation (even in financial systems) is a good thing, and the real issue is translating the complexity – there are time gaps in this, e.g. mortgages would have been deemed too complex a century ago.

On a lighter note, he pointed to the paradox that “
everybody knows that the dice are loaded…,” yet nobody sees it.

Jay McMahan, Enterprise Risk, Deloitte, in a talk provocatively titled “ The Dark Knight: Looking for organized uncertainty”, started with
Frank Knight’s classical distinction between risk and uncertainty. 
Drawing on Michael Raynor's work on the Strategy Paradox, he suggested that shorter-term decisions are exposed to measurable risks and should concern operations and business unit managers, while longer-term decisions are exposed to greater uncertainty and are the responsibility of corporate management and board of directors. Middle managers have the toughest job in linking these, through balanced scorecards, and other tools such as scenario-based stress testing (that his colleagues are using). His main conclusion was heartening: relying upon more sophisticated (opaque) quantitative models is not the solution – strategic thinking is vital to managing uncertainty.

Chris Robinson of York also shared the importance of strategy, mentioning how everything in financial accounting models discloses or measures
Returns. Risk information and assessment comes from the future and is only possible through understanding a business and its strategy – including such exercises as sending finance students to actually see, for example, how pulp and paper is made!

Earlier, Mark Adams of Edenbrook Hill Capital served a note of warning, pointing out that since 2007-08, risk went from capital markets to banking systems and corporate credit, and finally to sovereign credits, resulting in a “socialization of risk.” Surprisingly, while European banks have not even started unwinding of leveraged (debt) models, North America already has over 60% underway. While supporting existing models, he accepted that the challenge is to capture “regime shifts” and account for “blind spots” in models – his conclusion being that people who use models, not the models themselves are to blame.

The sessions together highlighted the increased emphasis on understanding risk as a strategic issue, with the need for joint ownership of risk amongst top management in organizations, as opposed to keeping it an isolated functional area. As McMahan concluded, integrating risk management and strategy is the next big issue. A question he left for researchers: why is there such little research on business failures?

The Knowledge Exchange events are a wonderful initiative - we should mention our bias given that SaY's founding contributor has been a discussant at an earlier
event. We need more on these lines.

1 comment:

Daryl Schindler said...

Good writeup. The event was definitely one of the more interesting ones I have attended.

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