Compliance and risk management: global trends
After decades in the doldrums, risk is suddenly a hot topic. Three things in particular have helped to make it a big issue: writedowns, rogues and Bear Stearns.
According to the Bank for International Settlements, banks' total writedowns on financial products related to US sub-prime mortgages and other undesirable investments totalled $503bn globally by September 2008. The argument goes that if only risk managers had pointed out the dangers of trading in complex derivatives based on sub-prime mortgages, banks would now be a lot better off.
So, how did banks - which should sure have known better - get themselves into such a state, and why didn't risk managers do anything to prevent it? It was partly because with traders making so much money, risk managers didn't want to spoil the party by suggesting money might also be lost as well as gained. And when they did, they were often overruled. Merrill Lynch, for example, has made some of the biggest writedowns of the lot. According to an article in Financial News, some risk managers who objected to the bank's strategy in 2006 were either overruled or demoted.
Banks, and risk managers, also made some wrong assumptions. One was that there would always be demand for mortgage-backed products. As a result, banks held the most highly rated - and therefore least risky - tranches of products like CDOs on their balance sheets. In fact, once the crunch hit, these AAA products became just as undesirable as the more risky ones.
Rogue traders are also high on the agenda. In January 2008, Jérôme Kerviel, a relatively junior trader at Société Générale in Paris, managed to inflict a €4.9bn loss on the French bank by building up a large position in equity derivatives.
Lastly, Bear Stearns (for anyone who's spent the past year in a cupboard) was a once-venerable US investment bank, which lost $10bn in liquidity in just one day and had to be bailed out by the Federal Reserve and JPMorgan.
Bear Stearns' sorry demise, and the credit crunch in general, have underscored the importance of 'liquidity risk', or the risk that no one at all will want to buy an asset whose price is in free fall.
Meanwhile, compliance teams must adapt to the new (and ever-changing) regulatory environment. For instance, the Markets in Financial Instruments Directive (MiFID), introduced by the EU as a framework for harmonising investment regulation in member states, has kept them busy in recent years.
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