Risk a is a 4-letter word…

The recent, very public lament by Doug Flint, Chairman of HSBC (and thus head of one of the largest and most complex financial institutions on the planet) that his colleagues were becoming too risk-averse and that the bank had 24,300 (sic) or about 10 percent of its staff “specialized” in risk and compliance, set us thinking about the management of risk- and how it seems to be becoming a “4-letter word” in certain quarters, while in others (such as the equity markets) “risk-on, risk-off” continues as before.

Quite clearly, when a bank has such a high proportion of its employees engaged functionally in risk management and regulatory compliance, there is something strange going on. Some of us at Awbury have been around long enough to remember a world when compliance departments did not exist; ERM was a throat-clearing exercise; and risk management was a relatively straightforward process, intended to make sure that loans were repaid on time. Halcyon days…

Now, of course, “risk” is everywhere; yet paradoxically it remains diffuse and often hidden. As the spectacular, but so-far relatively contained, implosion of Portugal’s Banco Espirito Santo demonstrates, risk can appear out of a seemingly clear blue sky: the bank was not brought down by its basic banking business or Portugal’s protracted economic problems, but because of its exposure to the collapse of a number of holding companies within its single-largest shareholder, the BES Group- the regulators’ “group risk” indeed!

It is not an exaggeration to state that global regulators and central banks have become obsessed with discovering where “risk” may have gone, or the form into which it may now have mutated. Is it still hiding in plain sight in the opacity of banks’ balance sheets; or lurking in the under-regulated “shadow-banking” systems? Will BlackRock and its ilk be responsible for the next financial crisis; or the failure to get macro-prudential policy right? Naturally, no-one really knows; yet everyone is supposed to have any opinion.

At Awbury, we are firmly of the opinion that one must be aware of and understand the fact that it is not usually the “obvious” risks that are likely to cause the most harm, but those that may seem  improbable or inapplicable; the nightmare of unforeseen “event” risks. This requires a flexible and unconstrained approach to risk-identification, trying to avoid the dangers of mental “framing” and being ever-vigilant about the risk of the improbable becoming the possible, then the likely. It also requires the use of what might seem “old-fashioned”, but are in fact axiomatic risk management tools- such as ensuring alignment of interests and the avoidance of adverse selection; full disclosure; careful structuring; and attention to detail. We believe strongly in focusing on a few transactions at a time, so that we can devote the appropriate level of attention to due diligence, remaining within our core competences.

So, risk is a 4-letter word.  It requires respect.

-The Awbury Team

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