The Professional Risk Managers International Association A Higher

The Professional Risk Managers’ International Association A Higher Standard for Risk Professionals Enterprise Risk Management – The Benefits of an Integrated Risk Strategy Geoff Kates Chairman, PRMIA Geoff. kates@prmia. org

Format of Presentation Ø Defining ERM Ø Using ERM to Inform Risk Appetite A Higher Standard for Risk Professionals Ø Integrating Risk Streams Ø Capital Allocation Ø Delivering ERM Ø Questions?

A Higher Standard for Risk Professionals Defining ERM

The Purpose of ERM Ø Aligning the entity’s risk appetite and strategies A Higher Standard for Risk Professionals Ø Creating a single language for discussion of risk issues Ø Reducing the frequency and severity of operational shocks and losses Ø Identifying and managing overlapping risks from different business lines Ø Improving the effectiveness of capital allocation

The Essence of ERM Ø Important that ERM adds value and does not just pay ‘lip service’ to the concept A Higher Standard for Risk Professionals q Countrywide’s commitment to ERM much heralded 12 months ago q ERM is not about box ticking Ø Aim is to provide valuable information to senior management to enable them to make informed decisions

Intertwining Risks Ø ERM is about more than Market, Credit and Operational Risk A Higher Standard for Risk Professionals Ø Critically can now also provide a framework for the management of liquidity risk q Unified assessment of the bank’s liquidity position Ø Other risk factors less tangible but just as important to the health of the bank q Reputational risk q Organisation risk q Compliance risk

A Higher Standard for Risk Professionals Using ERM to Inform Risk Appetite

Aligning Risk Appetite and Strategies Ø Fundamental to define and articulate risk appetite appropriately A Higher Standard for Risk Professionals q Conventional risk vs. reward decisions to be taken Ø Communication of this risk appetite can determine its success q Entire enterprise needs to be ‘risk aware’ Ø ERM does NOT simply provide a ‘risk number’ for the bank q Provides detail and colour to the view of risk

Aligning Risk Appetite and Strategies Ø ERM provides the basis upon which to transfer risk appetite into actionable business strategies A Higher Standard for Risk Professionals Ø Holistic risk decisions flow down into business planning Ø Drives awareness of the bank’s wider risk objectives within previously siloed lines of business Ø Front Office acts as a reflection of firm’s risk appetite

Creating a Universal Language for Understanding of Risk Ø Risk management previously defined by the complexities of individual risk streams A Higher Standard for Risk Professionals Ø ERM broadens the discussion to allow for consideration of the primary goal i. e. The Enterprise Ø Brings risk streams together to articulate a bank’s risk culture q ‘Common objectives through shared awareness’

Establishing an Effective Risk Culture Ø ERM is inextricably linked to risk culture throughout the organisation A Higher Standard for Risk Professionals q The transfer of risk appetite from senior management into the business Ø Requirement to harness interests of revenue generating staff and align with bank’s overall objectives Ø ERM delivers a systematic and rigid way of instilling culture q Performed through the ERM process

A Higher Standard for Risk Professionals Integrating Risk Streams

Handling Overlapping Risks Ø Past 18 months has forcibly demonstrated that risk factors do not operate independent of one another q Risk factors are inextricably linked A Higher Standard for Risk Professionals Ø ERM provides a mechanism to assess and manage these overlapping risks q Seeks an understanding of what is driving enterprise risk Ø Starts with the fundamental – e. g. Market and Credit Risk Ø Incorporates the less quantitative – e. g. Reputational and Compliance Risk

Driving Towards an Unified Approach: Integration Ø Integrating market and credit risk seen as an essential first step A Higher Standard for Risk Professionals Ø Recent events have made this a priority for many q Facilitates effective credit mitigation Ø Risk management processes then extended to the financial management of the enterprise q Facilitated by the advance of credit derivatives Ø Assists measurement of volatility of revenues, expenses and asset and liability flows

Liquidity Management Ø Management of liquidity position enhanced by ERM A Higher Standard for Risk Professionals Ø No longer considers liquidity in isolation Ø Liquidity risk becomes a key component of all risk assessment

Meta Hedging Ø Fundamental role of ERM decision-making is meta hedging A Higher Standard for Risk Professionals Ø Taking large positions to hedge exposures of whole lines of business during market turmoil q Bear’s move away from this strategy proved extremely costly Ø ERM should act as a way of reporting to senior management the bank’s various risks q Allows for strategic enterprise-wide decision making

Enterprise Exposure Visualisation Ø Credit crisis has emphasised value of understanding enterprise exposure q 3 weeks to identify true exposure to Bear Stearns A Higher Standard for Risk Professionals Ø Integration of risk streams and processes allows for near real-time appreciation of enterprise exposure Ø Dashboard at enterprise level facilitates identification of risk concentrations q Demands extensive data and systems integration and real-time data capture

A Higher Standard for Risk Professionals Capital Allocation

Capital Considerations Ø Global enterprises demand global risk policies / processes A Higher Standard for Risk Professionals Ø Difficulty in aligning global regulation with local enforcement Ø ERM allows for more effective capital allocation across individual entities Ø Global banks can make full use of diversification q Ensures adequate allocation at subsidiary level q Capital allocation becomes a dynamic management tool

Capital Considerations Ø Base business and risk information assimilated by the enterprise layer A Higher Standard for Risk Professionals Ø ERM allows for top-down allocation with a full appreciation of the enterprise picture q Risks can be diversified across the entity structure q Entities are capitalised to maximise business opportunities

A Higher Standard for Risk Professionals Delivering ERM

The Mechanism of ERM Ø Split in evidence over whether or not a specific ERM function is employed A Higher Standard for Risk Professionals q Some firms pursue ERM philosophies out of Group Risk q Others depend on the CRO to drive enterprise risk thinking and pull together a cohesive enterprise risk picture Ø ERM also viewed as an educational tool

Revising the Technology Architecture Ø Technology implications of ERM are complex and burdensome A Higher Standard for Risk Professionals Ø Involves integrating numerous data sources and cross-functional processes Ø Need to develop granular drill-down functionality from enterprise level Ø Enterprise risk visualisation involves converging disparate systems, data, processes and people q Vital that underlying data retains its integrity q All iterative processes and new governance structures are of little use if data is invalid or inconsistent

Questions? A Higher Standard for Risk Professionals

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