The frailty of VaR

A great article from way back when in January by Joe Nocera of the New York Times. It looks at the frailty of VaR and should be required reading! Click here.

OECD Report

As I have either said, or hinted at elsewhere, I was commissioned by the OECD to review Corporate Governance, risk management and remuneration in the banking sector in the UK, the US and France. My report has now been published, and can be found in full here. The same link will also take you to a shorter summary report. Be warned that the full report is over 50 pages long...

What people have said about the report:

• Insightful"
• a "pithy summary"
• "This is a strong, impressive report. Your grasp of the issues in a still-unfolding international financial disaster is not only impressive, but lends credibility to your recommendations which, taken together, are peerless. I hope that they are widely read, debated and, ultimately, implemented. I will not comment on each of your recommendations, nor your analyses and arguments in support of them, because there would be nothing substantive that I could add."
• "I have to read about risk day in and day out on the day job so for balance I prefer to read about other topics. But ... I made myself read it and I am glad I did. You paint a valuably comprehensive picture, and propose many innovative solutions."

I would welcome your feedback and thoughts as to how we can take the debate further.

Also, go to the OECD's website to see what else they are doing on the governance front.

Myners and boards

I think Lord Myners comments on boards are well worth reading. See here.

I am not sure about having a "Devil's Advocate" in that sounds a bit like having someone on the board just to be contrary. But I do agree that we need to do something about creating a counter-balance to what I have described elsewhere as the "red-blooded, testosterone-charged" CEOs of this world.

I would be interested in feedback

The SFO calls... Recessionary tales of the unexpected

Who will your disgruntled employee talk to first? You or the SFO? The SFO is putting paid for advertising into the media asking for whistleblowers to come forward see here, or for a legal perspective, see DLA Piper’s note on the subject: see here.

What are the business implications? What can you be doing right now?

Here we are in the worst recession in ages, if not since records began, and employees are under incredible pressure to produce results. Investors want results, boards are demanding results, managers are shouting for results, and who produces them? But staff cannot pull rabbits out of hats, so they are feeling coerced into manufacturing results that simply do not exist.

People who have led blame free lives, who would not say boo to a goose, are being encouraged to come up with results for their managers, or risk losing their jobs. Accountants and others are losing sleep over the “temporary” adjustments they have made – all in the expectation of making good next month. Except next month is even worse. Ask Bernie Madoff – and look where he ended up.

These staff, who are under excruciating pressure need to be able to let off steam. So who will they call: someone in your organisation, or the SFO? Indications are that more and more people are calling the SFO. And while we can all applaud the efforts to catch the crooks – is this really where you want to be spending your hard-earned management time: dealing with an SFO investigation?

So what can you do?

1. Review your ethics and compliance approaches: do you have an ethics programme? Do you know that you are in compliance with legal and regulatory requirements? Is it time to dust your programme down and remind people that is exists? Or do you need to create a framework right now?
2. Ensure that you have space for staff to let off steam. Vague whistleblowing policies about letting someone know somewhere in the organisation don’t usually work: there needs to be an independent (but that does not necessarily mean outsourced) mechanism that is both credible and seen to work. Make sure that communication programmes are in place, and that people feel that ethics is as much there to support them as it is for the organisation. This needs two-way risk-free communication.
3. Conduct an independent, anonymous survey of attitudes amongst senior managers and front line accountants – those who are most likely to know what is going on. Surveys in the States have shown that whereas a typical whistleblowing facility may have 1% of the staff using it for its primary purpose, a further 4% might explore ideas which could prevent abuses. And yet as many as 50% of staff, according to surveys, claim to have witnessed illegal or potentially seriously embarrassing unethical behaviour. Where did that 45% go?
4. Talk to partners, suppliers and customers – proper engagement with them, so that you have a dialogue which helps to reveal where pressure points are in the value chain.
5. Review those reconciliations and funny accounts – all the ones that are full of judgemental values. This is often where dodgy results start – implement a zero-tolerance policy with regard to unauthorised adjustments to these accounts.
6. Get your internal auditors on to the case: a few deep dives into trial balances and transactions sends out a message.
7. Bring your risk management down from the Olympian heights of governance compliance and turn to operational risks.

And if all of that sounds like yet more expense – well its better than having your collar felt by the SFO because you never got round to it...

Oh, and while this has a UK flavour (note the "u" in that word) it is relevant right round the world.

Turner Report

Lord Turner, Chairman of the FSA, set out his proposals for reforming the regulation of banking in the UK on 18 March 2009. The report emphasises, amongst other aspects, the importance of changing from a "light touch" approach to managing on a systemic basis. However, he does acknowledge the importance of Corporate Governance and internal risk management procedures, although final proposals await the Walker Report which will be published in October 2009.

The brief section on governance and risk management is nontheless interesting in that it illustrates the thrust of likely changes. I have reproduced this section in full below

2.8 Risk management and governance: firm skills, processes and structures

Analysis of the causes of the crisis suggests that there is a limit to the extent to which risks can be identified and offset at the level of the individual firm. Chapter 1.1 described how the origins of the crisis lay in macroeconomic imbalances and systemic developments: Chapter 1.4 argued that there are limits to the effectiveness of market discipline; and Section 1 of this chapter stressed that the crucial shift required in regulatory philosophy is towards one which focuses on macro-analysis, systemic risks and judgements about business model sustainability, and away from the assumption that all risks can be identified and managed at a firm specific level. As a result most of the changes proposed in this review relate to the redesign of regulation combined with a major shift in supervisory approach.

But improvements in the effectiveness of internal risk management and firm governance are also essential. While some of the problems could not be identified at firm specific level, and while some well run banks were affected by systemic developments over which they had no influence, there were also many cases where internal risk management was ineffective and where boards failed adequately to identify and constrain excessive risk taking.

Achieving high standards of risk management and governance in all banks is therefore essential. Detailed FSA proposals will await the outcome of the Walker Review (described below) but the key dimensions of required improvement are likely to be

• Improved professionalism and independence of risk management functions. As already outlined in Section 2.7 above, the FSA will therefore in future play a more active role in assessing the technical competence of senior risk managers. And it will consider whether governance structures for risk oversight need to be changed, with a more direct relationship between senior risk management and Board risk committees
• Risk management considerations embedded in remuneration policy, in the fashion described in Section 2.5 (ii). This has implications for the remit of remuneration committees and for the non-executive time commitments required
• Improvements in the skill level and time commitment of non-executive directors. The crisis has revealed the extreme complexity of large banking groups and the difficulties which nonexecutive directors (NEDs) face in understanding all dimensions of the risks being taken, within the time commitments typically required of NEDs. It has also raised questions about the degree of technical skill and experience required to perform risk committee functions, and whether existing bank boards have sufficient people with these technical skills. In addition it has demonstrated the vital importance of non-executive challenge to dominant chief executives pursuing aggressive growth strategies
• Shareholder discipline over corporate strategies. As Section 1.4(iv) described, shareholder influence seems to have been relatively ineffective in the past in constraining risky strategies. There may be ways of improving the effectiveness with which shareholder views are communicated to non-executives

These issues and the implications for overall governance principles and structures need to be looked at in an integrated fashion. One question they prompt is whether the governance arrangements appropriate for banks are different from those which apply to the generality of companies, and whether therefore codes and rules which go beyond the general Combined Code are required

These issues will be in part addressed by the review of bank governance being conducted by Sir David Walker which the government announced on Monday 9 February and which will report in October 2009. The FSA, which is providing the secretariat for this review, will work closely with Sir David Walker in consideration of these issues. Once the review has reported, the FSA will consider what changes to its rules and process are required to ensure that problems are addressed, making specific proposals by the fourth quarter of 2009

It will be interesting to see how this turns out under both the FRC review of the Combined Code and also the Walker review. For what it is worth, my view is that there is nothing intrinsically different about the governance of financial institutions just because they are financial institutions. While clearly there are differences in the technical aspects of risk, what seems to me to be more important is the potential societal impact of poorly handled risk in an organisation. Poorly handled risk in say chemical companies can be as (or even more) devastating than in banks: look at Bhopal or the BP refinery problems in the US. I am more interested in big v small impact organisations. One key difference may be whether there are Critical National (or International) Infrastructure implications, or whether there is scope for major disasters. I add the latter, because I am not sure whether Pharma companies are part of the CNI, but they can have devastating impacts (eg Thalidomide)

For the full detail of the Turner Report, click here...

Gordon Brown on Changes Needed

Gordon Brown on the changes needed: This article highlights the changes that GB is looking for in the global financial system. Well worth looking at. More...

GSO Finance Ministers

G20 Communiqué from the G20 Finance Ministers. It will be interesting to see whether Corporate Governance forms part of the stronger regulatory and oversight regime: hard to imagine that it won't. More...