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Alternative Strategies - A year away from the City - April

Patrick HealyYou probably do not recognise the name of William McChesney Martin Jr. but the comment by America’s longest-serving central banker that it was the job of the Federal Reserve to “take away the punch bowl just as the party gets going” might ring a bell.

Any barman will tell you that taking away the drinks before people are finished is a tricky job.

If you are Chairman of the US Federal Reserve then at least you have muscle to do it without getting beaten up (or at least getting fired).  The hardest and most important part of the job of a risk manager is the delivery of bad news.  Delivering bad news is never fun and telling someone to stop doing something that is making them lots of money does not make you any friends.  As with Fed Chairmen, risk managers may not get the timing exactly right either and if you were unpopular when you made your trader stop then you are detested if he sees traders in other banks carry on and continue to make money.  Traders and, in general, banks will want to trade right to the point when the market turns because, whatever anyone tells you, they are rewarded by the amount of money they have generated and not for their wise decisions to get out in good time.  Berkshire Hathaway could afford to ignore the boom in dot com stocks but it missed making a lot of money before the market collapsed.  Lots of traders and risk managers would have been fired before they were proved right.

A wise board will create strong risk management functions and recognise that profitable activities will sometimes have to be shut down.  Man Group was notably good at creating strong risk management.  The market crash has provided us with a lot more information about which other companies were not so good.

Some of the companies whose boards were less wise or less alert had, consciously or unconsciously, decided to save a lot of money in the short term by simply giving the appearance of risk management without putting themselves in the painful position of actually having to apply it on a serious basis.

If you think that your company would prefer to make short term savings in this way I have set out a few points below to help you set something up that will do everything your company needs from a risk department (except managing risk).

  1. Hire underqualified people or, better yet, move the dead wood from other parts of the organisation into the risk department.  A good headcount gives an impression of effectiveness so the more the merrier. 
  2. Ensure that certain parts of the organisation are off-limits; especially star traders.  There should be nothing formal about this and definitely nothing in writing but it can be done quite easily with nods and winks.
  3. The head of the department should have minimal authority.  Exclude him or her from the key meetings and if the regulators make a fuss then ensure that the important decisions are taken elsewhere.  In reality you can probably just change the names of the meetings.
  4. Ensure that reporting line for the head of risk goes to someone who can be relied on to do the right thing.  In this way even if the head of risk feels that something should be done it can still be buried quietly.
  5. The risk department should be required to produce lots of reports, the thicker and more incomprehensible the better.  Management do not have to read these; they are primarily for the regulators and but you can provide them to any non-executive director who gets too nosy.  The more unreadable the reports the less likely it is that there will be any awkward questions so the use of abstruse mathematical formulae and meaningless diagrams should be encouraged.
  6. Curiosity and initiative by the risk department should be vigorously discouraged.  In fact, the more the can be kept in their own offices the better so if possible move them as far away from the business as you can.  You can justify this as a means of ‘maintaining their independence’.
  7. Keep the risk department busy. Getting them to write procedure manuals is a good way of doing this as they will always need to be updated.  They look good for the regulators too and any discrepancies with actual practices can be explained by the fact that the manuals are ‘only drafts’ (they will always be ‘only drafts’).
  8. In terms of risk capital it is simplest just to work out the numbers you want and then work toward them.  Remember that while you may be bound by regulatory formulae there is always room to work with the assumptions.  This is particularly easy for operational risk.

Photograph by Lucy Reeve.

I was fortunate in working for companies with good and real risk management but discussions with peers at conferences, particularly after a few drinks, reveal that this is not the universal experience. However, I am writing this article at The End of the World so perhaps this is the reason for my outbreak of cynicism.

In this case The End of the World is a place rather than a time: the town of Ushuaia at the very tip of Tierra del Fuego.  It is a strange claim to fame, but at 620 miles from Antarctica it is probably sustainable, even if it is an odd basis for a tourist industry.  We have flown down from the sunshine of Buenos Aires to sub zero temperatures here to catch some of the sights before it gets really cold.

Photograph by Lucy Reeve.

It is bleakly, starkly beautiful here and while the origin of Ushuaia as a prison colony is symbolic of its remoteness, the town itself is now, if not pretty, at least quite pleasant with a surprisingly large number of quite upmarket shops catering for the wealthy foreigners boarding ships here for the fantastically expensive Antarctica cruises.

Photograph by Lucy Reeve.

We are slowly adjusting to the real foreignness of South America after the gentle Britishness of New Zealand.  Argentina is a relatively gentle introduction but next stop: Brazil.

Patrick Healy was the Group Head of Risk Reporting for Man Group plc
© Patrick Healy

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