AFTER THE CRISIS: Re-engineering Risk Management?
Thoughts from market experts including senior fellows and members of
the
board of directors of International Association of Financial Engineers
(IAFE)
(a synopsis)
The recent financial crisis exposed many flaws in the business procedures and incentive models within the global financial sector. After more than 20 months of analysis, debate, bail out plans, and crisis talks; local, global, internal, and public scrutiny have left us speculating whether the financial sector will ever regain its reputation. Meanwhile proposals for global regulation from nation states (particularly the US and UK), international entities (such as the EU, BIS, G20, IMF), and private institutions (such as ISDA and IOSCO), are forcing institutions to look into every aspect of their risk management functions. This paper gathers the thoughts and opinions of senior fellows and members of the board of directors of the International Association of Financial Engineers (IAFE) who talk openly about the issues surrounding the stability of the financial engineering community and what needs to be done to control the complexity of financial risk management.
Was Financial Engineering to blame?
The charge that the complexity of financially engineered products overwhelmed the ability of the system to cope with risk is often made in the press and media. However, our panel of experts is skeptical and point to less systemic causes. ...
In general our commentators were in favour of specific, well thought out technical improvements. For example, most of our risk panel supported moving standardized OTC transactions towards central clearing parties (CCPs) even though doubting that it would be a panacea. Some of our commentators noted that complexity was always conditional on the ability of our systems and processes to handle it, and that too often, different parts of the system had not developed at the same speed as the front office, and that management ultimately had to take responsibility....
Mark to Market
A common whipping boy of the crisis was the use of mark-to-market (MTM) accounting. Although cognizant of the difficulties, none of our respondents wanted a move away from MTM pricing.
So what of the future?
All of our respondents acknowledged the importance of a global approach and global institutions (or at least carefully coordinated national actions) to deal with systemic risk. Harmonization of national policies, to avoid regulatory arbitrage was needed, but few were confident that the path would be an easy one.
1. Predefined Government and Regulatory Responses
2. Enhanced Capital Requirements
3. Too-Big-To-Fail
It seems size although an imperfect measure
of risk, it really does matter.
4. I Improved Corporate Governance and Risk Management in Financial Institutions
5. A Accounting Standards
None of our panellists advocated wholesale retreat from MTM, but most wanted some flexibility in the way it was applied in practice,
Conclusions
The clearest conclusion to be drawn from the above discussion is that the financial crisis was far too complex to be reduced to a single cause or even a handful of factors
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