Risk is in the air…

As readers of this blog will appreciate by now, at Awbury we are thoroughly paranoid about properly identifying, understanding and controlling risk in all aspects of our business. To that end, we try to keep an eye on what others may identify as “emerging” risks. Of course, such a task is meant to be part of the job description of any self-respecting CRO (and team). However, much of what one reads still resembles little more than a consensual box-ticking exercise: “We’ve thought about is, so everything is now OK”.

In reality, what tends to happen is that a document is created, and then filed away somewhere; to be brought out, when necessary, as evidence of diligent behaviour.

As such, it is worse than useless, because it provides a false sense of security. And if we have learned nothing else in this world, we know that one should never feel secure when it comes to risk management! The advent and outcomes of the pandemic amply demonstrate that!

Another perennial problem within risk management is what we would term “compartmentalization”, meaning that one can neatly classify risks into discrete categories, and so produce labels to summarize them. Checklists do have a value, as we have written before, and are sometimes essential, as long as they are seen as the start of a process, and not an end in themselves. Unfortunately, labelling can also lead to the problem of “framing”: we have defined the risk, and neatly labelled it, so it must fit, and we now understand it fully. As Wittgenstein said: “The limits of my language stand for the limits of my world”. (Die Grenzen meiner Sprache bedeuten die Grenzen meiner Welt). I have “named” it, so that is what it is.

However, the real world is messy, not neat; and one has to be comfortable with managing disorder and often indeterminate continua of outcomes, and acting accordingly. Interestingly, we suspect that in many organizations this may lead, paradoxically, to decision-paralysis in the face of uncertainty, or, conversely, to precipitate action, because: “We must do something!”

Naturally, we are not saying that any of this is easy. It is not. However, it is possible to be better prepared through constant research, wide reading, and continuing dialogue and discussion, with a view to risk identification, scenario planning and gaining an understanding of the realistic boundaries of risk.

The pandemic has been an object lesson in “real world, real time” risk management and mitigation, because it combines scale, speed, reach and uncertainty with behavioral impacts. It is truly a “messy” and evolving event; and one which cannot simply be categorized and “boxed”. Although it is now possible to create some parameters for cause, effect and consequences, one also has to recognize that believing that one fully “understands” the risks is foolhardy.

So, at Awbury, we constantly update our assessment of the risks which the pandemic poses (as well as of the opportunities it may provide in terms of creating new products for our clients) to ensure that we are prepared to deal with any realistic scenarios as the evolve and appear- hence the paranoia!

The Awbury Team

What could possibly go wrong…?

Being in the business of helping our clients manage complex credit, economic and financial risks, perhaps not surprisingly we the Awbury Team has a certain necessary fascination with how to understand and analyze the material risks any Obligor faces.

Over time, a number of attempts have been made to provide a systematic classification of such risks, the latest (and most comprehensive of which) is the (Cambridge Taxonomy of Business Risks), which uses what one might call a quasi-Linnaean system involving 6 Primary Classes, 37 Families and 175 (sic) Types.

The results are useful because they provide what one might call a checklist (cf. Dr. Atul Gawande’s “The Checklist Manifesto”) for any risk analyst or underwriter to set against the nature and complexity of the entity she or he is reviewing and assessing.

Of course, it is easy to mock a list that contains 175 Types as being far too complicated to be useful. However, the mere fact of its existence should at least compel an analyst to look at the risks which a business faces holistically, and consider which ones are material; or, if they arose, could potentially lead to failure and default. And bear in mind that many regulators require companies to maintain Risk Registers- which, in reality, are analogous to a basic taxonomy of risk.

The Taxonomy does not weight the risks, because, quite clearly, that (and their relevance) varies from entity to entity. However, the authors do comment that, of the 6 Primary Classes (Financial, Geopolitical, Technology, Environment, Social and Governance), Governance risk is often underestimated; while “Geopolitical risks and possibly Financial, [may be] being overestimated. And, yes, “Infectious Disease” is in there as a Family!

The “art”, therefore, lies in looking at an entity and determining the material risks to which it is subject, particularly the potentially “existential” ones. As the pandemic has brutally demonstrated, the trope “lack of cash (and liquidity) kills companies” has never been more true, even if no business executive is ever likely to have planned for revenues to fall to (perhaps) zero for what was hitherto considered a viable and well-run business.

This just serves to emphasize that it is not the “usual” risks that are likely to cause systemic issues (although they may have an idiosyncratic impact), but rather the ones thought to be out in the tail of any distribution. Perhaps ironically, one could clearly argue that the pandemic was a 1-in-100 year risk which should have been factored into (re)insurer risk models (as it surely will now be!), as other 1-in-200-, 1-in-250- and 1-in-500-year risks habitually are for NatCat programmes. This is not, in any sense, to denigrate the (re)insurance industry, because it was governmental behaviour and actions that caused the most harm in economic and loss-exposure terms, not the disease- in other words, a second- not a first-order effect- and that clearly now belongs in any taxonomy of risk under “Government Action”!

The pandemic also demonstrates the fact that world of risk is not Aristotelian and fixed, but evolves and changes as forces and events act upon it- the SARS-COV-2 pandemic simply being the latest example. Checklists are useful, but only as a guide, not as an expression of the limits of risk. As we have written before, it is usually the risks that you do not foresee that cause the most harm.

The Awbury Team