How to sabotage any business

Being of a naturally curious disposition, we read a recent article by The Financial Times’ columnist, John Kay, entitled “Absurd roots of modern regulatory practice” with interest and wry amusement.

We have written before on the topic of the importance of creating the appropriate culture, governance and decision-making structure, recognizing that even the seemingly “invincible” business can be brought low by skullduggery and nonsensical “internal politics”.

Amongst other points, the article suggests that regulation, and hence how regulated businesses are governed, has reached a level of complexity and prescription that may enable those subject to actually abdicate any sense of personal responsibility for any error short of the deliberately criminal or fraudulent, quoting from an obscure, satirical pamphlet, called “Microcosmpographia Academica”, written by a Cambridge classic don, FM Cornford: “The more rules you invent, the less need there will be to waste time over fruitless puzzling about right and wrong. The best sets of rules are those which prohibit important, but perfectly innocent, actions. The merit of such regulations is that, having nothing to do with right or wrong…[they] relieve the mind of all sense of obligation towards society.”

One could argue that, being written in 1908 (sic), it prefigured Dodd Frank, “Basel 3 ½” and Solvency II by over a century! Better to dwell in the Valley of Indecision and blame someone else for anything that goes wrong….

By now, Dear Reader, you are probably wondering what this has to do with the reference to “sabotage” in the title. Well, consider the following:

(11) General Interference with Organizations and Production

(a) Organizations and Conferences

(1) Insist on doing everything through
“channels.” Never permit short-cuts to be taken
in order to expedite decisions.

(2) Make “speeches,” Talk as frequently as
possible and at great length., Illustrate your.
“points.. by long anecdotes and accounts of personal
experiences. Never hesitate to make a few
appropriate “patriotic”-comments,

(3) When possible, refer all matters to
committees, for “further study and consideration.”
Attempt to make the committees as large
as possible- never less than five.

(4) Bring up irrelevant issues as frequently
as possible.

(5) Haggle over precise wordings of communications,
minutes, resolutions.

(6) Refer back to matters decided upon at
the last meeting and attempt to re-open the
question of the advisability of that decision.

(7) Advocate “caution.” Be “reasonable”
and urge your fellow-conferees to be “reasonable”
and avoid haste which might result in
embarrassments or difficulties later on.

(8) Be worried about the propriety of any
decision- raise the question of whether such
action as is contemplated lies within the jurisdiction
of the group or whether it might conflict
with the policy of some higher echelon….”

Straight out of some slightly sardonic management text along the lines of “The Peter Principle” perhaps?

Actually, the above text is taken verbatim from page 28 of… “Strategic Services Field Manual No. 3”- as in the OSS, the forerunner of the CIA- with an introduction dated 17th January, 1944 signed by the legendary “Wild Bill’ Donovan. An interesting document, only de-classified in 2008! Much of it has an elegant simplicity, and is intended to enable an individual to cause mayhem at minimal personal cost.

Frankly, one could not make this up; and it is somewhat disturbing to reflect that the above behaviour is all too prevalent in many business organizations!

So, as we progress through 2016 and seek to navigate a potentially volatile and uncertain business environment across key sectors and geographies, in which “caution” may be deemed the better approach, bear in mind these 2 points:

1) Do not use regulation as the excuse for abdicating responsibility for doing the right thing; and
2) Do not succumb to an approach to corporate governance that, in reality, amounts to corporate sabotage and value destruction.

At Awbury, we believe that one has to be constantly on guard for signs of such behaviour. Questioning and challenging processes and decisions are essential components of managing any business; but they must be kept in check and used for legitimate purposes, not sabotage.

The Awbury Team

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Willkommen zu Solvabilität Zwei, Herr Schmidt

We thought that we’d allow our readers to recover from their year-end activities and get over the shock of the fact that Solvency II has actually happened after many draft iterations, much politicking and seemingly endless horse-trading. Even in this supposedly digital age, forests will have been felled to provide the paper required to print all the text of the Directive and its implementing Regulations- just try reading all of it on a screen! We aim to spare your eyesight from further strain.

So, what now? The earth did not shake, nor buildings tumble.

However, let there be no mistake that actually having to implement and abide by Solvency II, does represent a major change, not just for those subject to and directly affected by it within the EU, but also globally because of the fact that it creates a benchmark for other regulatory regimes across the globe, and requires any (re)insurance executive to pay attention to its implications.

Firstly, kudos to the BMA for achieving full equivalency. This will serve the important Bermuda market well in continuing to develop and expand its reach, with the Awbury Group one of the beneficiaries.

Secondly, it will make it much easier for anyone wishing to undertake a “contrast and compare” exercise on the financial capacity and capital strength of any EU-based (re)insurer somewhat easier (we would never say easy!), because of the need for companies to be seen to be more transparent in reporting, and greater consistency in how such information is presented. Yet care will need to be taken in distinguishing between those companies that will have to use the Standard Model, and those permitted by their national regulator to use an Internal Model (whether full or partial.)

Thirdly, as Solvency II tends to reward diversity and scale, there is likely to be some pressure on more specialized and smaller insurers to seek a larger partner, while the larger ones will seek to continue to increase in diversity and scale.

Fourthly, it will place more emphasis on the composition and quality, as well the quantum of capital, with companies benefitting from being perceived as having a capital base that it more resilient and less volatile.

Nevertheless, fifthly, and somewhat paradoxically, the fact that Solvency II requires an effective “marking-to-market” of both sides of the balance sheet, assets and liabilities, means that the Solvency Capital Ratio (SCR), which will become a key metric used in comparing companies’ financial strength, is likely to become more volatile, with the weightings enforced for varying exposures potentially having a more material impact and causing “capital strain”.

Already, there is talk that certain market sub-sectors, such as German life companies, and life companies more broadly, will suffer a greater impact from Solvency II’s implementation than general or “P&C” companies . Yet, all companies are going to have to look much more closely at the capital efficiency of their balance sheets; and how, in a still yield-constrained and volatile world, they can achieve better risk-adjusted returns, without unduly straining their SCRs.

At Awbury, having studied Solvency II, and with the benefit of our long experience in the insurance, banking and capital markets sectors, we have developed a number of strategies and techniques for helping our clients in the (re)insurance business manage their capital more effectively, while allowing them greater flexibility in, say, asset allocation. As such, we welcome the opportunity for dialogue on how we can be of service in enabling you to meet your risk/return and SCR goals; so, give us a call.

The Awbury Team

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So, are we all asset managers now?

In a world in which the largest asset managers, such as BlackRock or Vanguard, control more assets than any bank or (re)insurance group (with the total stock of assets under management now estimated at some USD 74TN, or even more by some counts); in which many banks are struggling with the demands of regulators that impinge upon their ability to earn an adequate return on equity; and in which traditional (re)insurers also struggle with the impact of commoditization of pricing and alternative capital, it is not surprising that the thoughts of many Boards and senior executives are turning to the attractions of asset management.

In the banking space, banks are focusing on building (or re-building) their asset-gathering and managing businesses to emulate the long-standing “Swiss model” and are also beginning to enter into partnerships with asset managers to co-lend; and there are the usual signs of herding and concerns about conflicts of interest if a bank adopts a “closed-architecture” model, as opposed to the increasingly prevalent “open-architecture” model, trying to restrict its clients to funds managed in-house, because, after all, their investment management skills are all “above average”.

While in the (re)insurance industry, there is much debate about the attractiveness and sustainability of the so-called “hybrid model”, in which more risk is taken on the investment side than have traditionally been the case, or capital allocated from the underwriting/liability side of the balance sheet to the asset/investment side if returns or volumes in underwriting are seen as unacceptable.

In any business, rationally, capital should be allocated to where it can generate the best risk-adjusted returns consistent with the enterprise’s business model and management capabilities. However, to us at Awbury the key phrase is “consistent with…management capabilities”. Not everyone has the capital-allocation skills and deep rationality of a Warren Buffett. We suspect that many managements may be deluding themselves that they can and will have the discipline to carry such an approach to its logical conclusion and refuse to write unprofitable insurance business or, conversely, not “reach” for returns that are only achievable because they carry with them risk that no (re)insurer concerned about its ability to meet all valid claims when due should be willing to accept.

And, of course, all the funds gathered by these asset managers have to be invested prudently and in accordance with the mandate provided by the investor providing them, whether a Sovereign Wealth Fund, or a manager pooling investments on behalf of individuals saving for retirement. This begs the question of where and how investable assets are to be generated if everyone is focusing on asset-gathering and not origination.

So, whether you are a direct investor in a bank, or in a (re)insurance company, it may be wise to keep an eye on whether or not its business model is mutating into an “asset management” paradigm and becoming indistinguishable from the rest of the herd and giving “style drift” a whole new meaning.

The Awbury Team

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