Risk Management and Portfolio Analysis

A Clear and Transparent Approach

Sound risk management should be based on clear and transparent high-level principles.

Simplicity is a virtue - complexity often arises as a result of a process of negotiation during which core risk management values get compromised, diluted and obfuscated.

An Approach Based on a Clearly Agreed 'Risk-Appetite'

If it is not possible to agree where the 'lines in the sand' lie, then there is always likely to be 'risk-creep', disagreement and misunderstanding at risk-critical moments.

There need to be agrees ways of benchmarking risk - which need not necessarily involve complex statistics.

An Integrated Approach

As markets become more complex, the divisions that have previously existed between risk management functions for different types of risk often look increasingly artificial and counter-productive.

A fragmented approach often means that there is an unnecessary duplication of data and systems, and inconsistencies in risk-perspectives.

A Layered Approach

A risk management framework can be made more robust by layering it so that it is based on multiple pillars which mutually re-enforce one another. In this context some 'duplication' is not always a bad thing.

An Informed Approach

Risk managers need to have a deep understanding of the things that they are managing - this is a particular challenge in some areas of finance, where complex financial instruments can be created and traded very quickly.

A Systems-Enabled Approach

Systems should be able to support and enable business processes, including risk management, rather than constraining them.

Business processes should drive systems requirements, rather than business processes being driven by the limitations of poor systems.

A Model-Aware Approach

Where models are used to quantify risk, risk managers need to understand them in sufficient detail to know how to interpret the results. This includes what they can and can't be used for, and what their assumptions and shortcomings are.

A Practical Approach

Experience and informed common sense are always at least as important as the results of statistical models - this sometimes gets forgotten in the understandable desire to quantify and analyse.

An Independent Approach

Management frameworks should be structured so that it is not possible for risk management decisions to be confused or influenced in an inappropriate way.

An Incentivised Approach

It is important that risk managers are properly incentivised for what they do, which is often about saying 'No' and appearing to stand in the way of short-term profit.

It would be very hard to convince most people who have ever worked in the financial world that risk managers who prevent losses would receive anything like the same rewards as traders who make profits of a similar size.