A day to remember

October 27th is the anniversary of Vasili Arkhipov's intervention that prevented a Soviet submarine firing nuclear torpedos at a US destroyer at the height of the Cuban missile crisis. Raise a glass in remembrance of a very gallant officer.

Regulation

The Americans are busily searching for the culprits of the financial meltdown and the SEC, FBI and others are beating the bushes, but in the UK the heads of the Bank of England, the FSA and the Government make speeches - various people from the Bank of England and the FSA are moving on, but it is safe to predict that no one will be found to be responsible except, of course, the bankers and hedge funds. It is fortunate for them that burning at the stake is out of fashion.

Lloyd's of London has had some experience of failed regulation and after the failure to recognize the imbecilic behaviour of a lunatic fringe, major reconstruction became necessary (without any contribution from the taxpayer). After this near death experience Lloyd's passed hundreds of new regulations and imported herds of regulators - there were more at Lloyd's than were considered necessary for the rest of the UK insurance industry - with dire consequences. The market again sustained many billions of losses but since corporate capital had arrived and the losses were overwhelmingly sustained by this capital rather than the Names, it did not attract much notice However, it was obvious that the legions of regulators were ineffectual and the missing key component was knowledge, which was in short supply, not power, which they had in abundance.

The current Franchise Board at Lloyd’s was created in response to this so that now regulation is firmly practitioner led. The Franchise Board came to power in a fast improving market environment but the current signs are promising: it has the power and the knowledge.

It is not clear that the Bank of England or the FSA really understood the nature of the risks which financial institutions were accepting or, if they did, that they had any clue what to do about them. The new regulations and armies of new regulators which will arrive on the scene as a response to current events will be similarly handicapped. Unless the regulators are really up to speed with what the markets are doing they will prove to be as ineffectual as before.

History – In 1929 the Willcox Syndicate at Lloyd’s insured the solvency of secondhand car dealers – with predictable results. Lloyd’s, thereafter, insisted that all businesses operating in Lloyd’s should agree not to accept Financial Guarantee risks. This interdiction has been slightly modified since but is still in force – some people do learn from history.

Thou shalt not underwrite financial instruments

A very knowledgeable friend remarked last week that ever since the 1920's when one Lloyd's syndicate caught a severe cold insuring some financial instruments which went badly wrong ,not to underwrite such has been one of the commandments which all Lloyd's underwriters must very consciously obey.

Not in front of the children

Blue Peter, the children's television programme, has celebrated its 50th anniversary this week. During this half century its presenters have climbed up Nelson's Column, jumped out of aircraft, gone into ice pot holes, caressed pythons in the studio and exposed themselves to all mannner of dangers. Unless I have missed something, which is quite possible because I have never been a regular viewer even when my children were of the appropriate age, there has never been a fatality connected with any of the myriad of stunts that they have done. Says something for the BBC's risk management - I wonder if Blue Peter were the orginator of the famous risk advice " Don't try this at home."

Risk Management and Pay

"If [remuneration] policies are not aligned with sound risk management, that is unacceptable. Immediate action will be required to change the policies".

FSA, 13 October 2008

Long term survivor

Some years ago, to celebrate an anniversary, I decided to plant a tree.

I chose a Ginkgo Biloba, which are to be found all over Japan and whose nuts when fried are delicious. They have a downside in that in season the females can be quite pungent so I have planted the tree well away from the house and close to the fence, so it will create a problem for any new neighbours if the farmer ever develops his fields for housing.

Not only is the tree fruitful, and very beautiful, particularly in Autumn when its leaves change to bright yellow, but also it is an example of one of the great survivors in nature, for there were ginkgo biloba trees growing over 270 million years ago when the dinosours were around. Some individual specimens can live to more than 3000 years; there are some ginkgos still living which were only 1-2 kilometres from ground zero in Hiroshima.

It seemed to me that anything that could survive the vicissitudes of such a long period would be a good bet against whatever climate change could come up with. It also appears in today's newspapers that ginkgo extract halts the onset of alzheimers - good risk management all round.

High Impact, low probability risk

For more than 10 years the Council of the Association of Insurance and Risk Managers ( AIRMIC) have insisted that their reserves be placed with three separate banks, despite their lead bank offering significantly better interest rates. An example of risk managing for what, for the last ten years, would have been seen as a high impact but low probability risk.

Who decides on the risk?

A Chief Executive and his Chief Financial Officer, faced with a deteriorating situation in their markets, decide on a drastic course of action, supported by their banker.

Under their governance rules they submit their plan to the risk management committees. The first risk management commitee, having talked through the proposals with the stakeholders refuses to support the plan, which almost causes an apoplectic fit from the Chief Financial Officer who is not used to such detailed risk management consideration of his proposals.

The second risk management committee, composed somewhat differently, then refines the plan, adds some additional controls and benefits and confirms their agreement with it.

It then remains for the first risk management committee to decide whether their concerns and those of the stakeholders have been sufficiently addressed.

Is this a model for future corporate governance and for putting the risk manager right in the centre of the risk management process at the point of the decision?

Spreading the risk

Here's a risk management story from Tom Cahill's report on Bloomberg today;

"John James, who runs the Chicago-based firm with $25 million of assets, didn't buy Lehman stock or debt. Instead, his potentially fatal mistake was to rely on the bank's prime brokerage in London, a unit that provides loans, clears trades and handles administrative chores for hedge funds. He's one of dozens of investment managers whose Lehman prime-brokerage accounts were frozen when the company filed for protection from creditors on Sept. 15. "

Never rely on just one provider, if you can help it.