ACCA FS NETWORK FORUM | RISK MODELS
The elements of a new risk synthesis and the role of financial models in managing risk ACCA FINANCIAL SERVICES NETWORK FORUM Whether financial models manage risk 27 February 2013
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ACCA FS NETWORK FORUM | RISK MODELS
Context
• • • •
Focus on context of risk modelling not the activity of risk modelling Place risk modelling in the context of governance and the firm’s risk system Rebalance the debate – putting people back in the equation Introduce a model of risk synthesis
© 2013 Paradigm Risk Limited. All rights reserved
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ACCA FS NETWORK FORUM | RISK MODELS
All models are wrong, but some are useful . . .
George Box, professor of statistics University of Wisconsin–Madison, 1987
© 2013 Paradigm Risk Limited. All rights reserved
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ACCA FS NETWORK FORUM | RISK MODELS
All models are wrong, but some are useful . . . The practical question is how wrong do they have to be to not be useful.! George Box, professor of statistics University of Wisconsin–Madison, 1987
© 2013 Paradigm Risk Limited. All rights reserved
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ACCA FS NETWORK FORUM | RISK MODELS
The analytic core • Effective risk governance puts the firm’s analytic core at the centre of decision-making (the so-called “use test”) • Data is the starting point for robust modeling • Modeling forms the basis of capital target-setting, allocation and capital pricing (charging) in the firm
© 2013 Paradigm Risk Limited. All rights reserved
controls!
analytic core"
data!
modeling!
capital!
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ACCA FS NETWORK FORUM | RISK MODELS
Systems & controls Central to reliability • Sound control over systems and robust data governance are essential for reliable modeling • The firm’s data architecture is central to its risk management capability • Systems provide the platform for limitsetting deployed throughout the firm • Effective control over systems is essential and a vital aspect of robust assurance
© 2013 Paradigm Risk Limited. All rights reserved
use of risk analysis" systems!
analytic core"
data!
deployment!
controls!
modeling!
capital!
limits!
behaviour" drivers"
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ACCA FS NETWORK FORUM | RISK MODELS
The firm’s risk strategy • The firm defines (models) its risk strategy through sensitivity (tolerance) to its capital position at a target level of performance at a preferred level of implied risk (appetite) • The firm communicates and operationalises its appetite and tolerance through its risk framework • The firm’s risk decisions are only as good as its people (competencies) and their understanding of risk objectives
© 2013 Paradigm Risk Limited. All rights reserved
use of risk analysis"
risk strategy! systems!
analytic core"
data!
deployment! behaviour" drivers"
appetite | tolerance" controls!
modeling!
capital!
limits!
risk competencies |" risk framework"
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ACCA FS NETWORK FORUM | RISK MODELS
Governance Corporate governance | Risk governance • Effective risk governance ensures the firm’s capital is central to all discussions about risk • Risk governance and internal governance (legal vs operating) structures should align clearly • Risk review and oversight are critical aspects of risk governance • Robust assurance is required over data & modeling and risk operations © 2013 Paradigm Risk Limited. All rights reserved
governance! use of risk analysis"
risk strategy! systems!
analytic core"
appetite | tolerance" controls!
data!
deployment! behaviour" drivers"
assurance"
modeling!
capital!
limits!
risk competencies |" risk framework" risk & internal governance"
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ACCA FS NETWORK FORUM | RISK MODELS
A coherent approach linking the analytic core to governance • Effective risk governance is about eliminating silos so the firm views its risk in an integrated way • Effective risk governance is a component of effective corporate governance and cannot exist separately from it • A firm committed to a robust response to the challenges of Solvency II must address the quality and performance of its corporate governance
© 2013 Paradigm Risk Limited. All rights reserved
governance! use of risk analysis"
risk strategy! systems!
analytic core"
appetite | tolerance" controls!
data!
deployment! behaviour" drivers"
assurance"
modeling!
capital!
limits!
risk competencies |" risk framework" risk & internal governance"
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ACCA FS NETWORK FORUM | RISK MODELS
Avoiding jargon about ‘corporate governance’ BOARD LEVEL
• The term ‘corporate governance’ has become so widely used that its meaning can be unclear • All forms of governance are subsets of corporate governance • Robust risk governance is a central aspect of effective corporate governance • Effective risk governance requires that the firm manage explicitly the relationship between subsidiary structure and subsidiary risk reporting, control & oversight • At operating level, ‘governance’ is synonymous with management, oversight & assurance © 2013 Paradigm Risk Limited. All rights reserved
Board performance
Corporate governance
External governance
Risk governance
Internal Company governance compliance
Shareholder relations
Risk strategy
Subsidiary structure
Capital structure
Risk framework
Subsidiary boards
Crisis fitness
Risk system
Risk management ! & operations OPERATIONS
Corporate secretary
EXECUTIVE LEVEL
Subsidiary operations
Data governance Programme governance
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ACCA FS NETWORK FORUM | RISK MODELS
A new risk synthesis 1/2 : Elements of the synthesis
MANAGERIAL
OBJECTIVIST
structural
ALLOCATIVE / " DECISIONAL
© 2013 Paradigm Risk Limited. All rights reserved
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ACCA FS NETWORK FORUM | RISK MODELS
A new risk synthesis 2/2 An organising framework
governance! use of risk analysis"
risk strategy! systems!
analytic core"
appetite | tolerance" controls!
data!
deployment! behaviour" drivers"
assurance"
modeling!
capital!
limits!
risk competencies |" risk framework" risk & internal governance"
Š 2013 Paradigm Risk Limited. All rights reserved
12
ACCA FS NETWORK FORUM | RISK MODELS
Guns don’t kill people . . .
© 2013 Paradigm Risk Limited. All rights reserved
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ACCA FS NETWORK FORUM | RISK MODELS
Conclusions We need a new risk synthesis
• ‘Solutions’ have focused on the easy bits – structural and analytical solutions – witness the solutions of the Walker review • Risk management in a firm is a human system – behaviour is essential . . . • . . . and unpredictable • Therefore firms’ risk systems behave like complex adaptive systems • Linear control solutions will be ineffective • Behaviour has been reasoned out of the equation • We need a new synthesis reintroducing behaviour as a core element and as a feedback loop to make risk systems effective . . . • . . . meaning attention (in the technical sense) to behaviour so . . . • Financial models don’t manage risk . . . People manage risk using financial models with apologies to the NRA © 2013 Paradigm Risk Limited. All rights reserved
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ACCA FS NETWORK FORUM | RISK MODELS
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Š 2013 Paradigm Risk Limited. All rights reserved
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