Executive Summary
With hindsight, the author suggests a practical process for re-inputting the people element to create an “early warning system” to prevent another perfect storm.
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In a near-global systemic meltdown, a contributing factor was inadequate transparency through the levels of the organization.
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As financial regulation revisions bite, there is an opportunity to re-input the “people” element in offering an early warning.
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By encouraging contributions at all levels through a systematic approach, CEOs, CFOs, risk, and top management can be more aware earlier of potential problems.
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Encouraging a climate of more openness would help, but this does not work in all cultures.
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The real challenge remains to extend that transparency as far as the regulator.
Introduction
It’s been an unforgettable 12 months, with multi-billion write-offs every week, well-established firms collapsing, fire sales, runs on banks, and as near to a totally global systemic meltdown as any of us will ever want to get. And we’re not out of it yet.
How can such well-established firms get it so wrong? Why did the risk departments and regulators fail so dramatically? Hindsight is a wonderful thing, but I firmly believe that one of the major contributing factors is the lack of transparency within financial service organizations; not only to the shareholders, but to senior management as well. When you combine this with record trading volumes, the complexity and opacity of derivatives, and the apparent acceptance of a greed culture, we clearly were hit hard by the perfect storm.
As an organization specializing in putting people and their input back into automated operations in the financial services arena, we have been very cynical for the last six or seven years about the traditional operational risk department’s focus. In a nutshell, it was clear to us that you cannot risk to manage trading and operational activities from the center of an organization, unless you have very strong personal input from the coalface, and total change in the culture.
Coming from the coalface, it has been clear to us that senior risk managers have very little visibility as to what is going on across the length and breadth of their organization, particularly where whole swathes of processes have been or are being outsourced, or sent offshore. In fact, I’d broaden that statement to say that most senior management struggle to have transparency over their own operation, let alone a risk manager.
My own background is in applications development. As a former chief information officer (CIO) at NatWest Global Financial Markets, I think of myself as someone who focuses on business problems and tries to generate sensible solutions to those problems. That is not quite the way things have been played in the regulatory field in financial services. Instead of a sensible approach to a business problem, we have a situation where the regulator sets the boundaries and the various players then push the envelope as hard and as creatively as they can.
So, when I watched the implementation of regulatory regimes such as Sarbanes-Oxley and Basel II, and saw the industry trying to “game” the regulations as they emerged, it seemed inevitable that these well-intentioned regulations were unlikely to serve their intended purpose. This is despite the fact that there is very little in the regulations that best practice or sensible management wouldn’t cover. Indeed, the firms thought they were being smart, whereas in reality most got a very poor return on investment from implementing solutions to such regulations.
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