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Issues in Operational RiskJames Tunkey, I-OnAsia October 26, 2009 Here we go againAdding Galleon and Raj Rajaratnam to the long list of reasons why due diligence and ops risk mgmt are so essential. Posted by James P Tunkey at 06:00 PM | Comments (0) March 06, 2009 RedemptionHow much money do you need? You could get a million dollars. And you could get it in cash. I know where it could be gotten. I mean its not easy, but it could be done. But, uh, the question is who the hell would handle it? Let me say there should not be a lot of people going around getting money. Richard Nixon Dont come to the table with the same worn arguments and tired ideas that helped to create this crisis. Barack Obama
Elsewhere, earlier in the week, AIG repeatedly was described in the press as operating as an internal hedge fund scheming outside of regulatory the tent. AIG allegedly assists European banks dodge Basel capital reserve requirements. BofA is also announced to be investigating Merrill hidden losses and non-transparency. Meanwhile in US Congress, SEC and NY insurance regulators were admonished for missing Madoff, AIG, others. It is known now for fact that the housing bubble was full of perverse incentives. AAA and models for valuing firm and transaction creditworthiness are in tatters. What was it the oil soaked duck said to his pal after a swim near Exxon Valdez? Massive clean-up continues to be necessary. Missing in the prior period was a realistic understanding of the control systems faults. What are the levers of control over the subject? How have they been tested? What are the terms of accountability? These affect the industrys profile. Redemptions (and market failure in general) are unlikely to halt until these market and government regulatory weaknesses are addressed directly and adequately. I have spoken in prior posts about the need for greater introspection as well. There must be greater attention paid to internal weaknesses. This goes beyond often weak bench strength (e.g. publicized reports of pre-allocation decisions in Madoff funds). It also addresses the vulnerabilities to fraud caused by internal staff and the market itself. On Monday I have been asked to speak about the profile of a fraudster. They are conscious active and adaptive opponents but have a variety of motivations. Fear will likely continue to be the driver for fraud for next 2-3 years with deleveraging and redemption pressures affecting management judgment. Tier 1 long established teams and particular individuals may also be motivated to fraud (perversely) by honor, and there are many sacred cows. Greed always a problem, and was the primary motivator in the boom (see prior posts). Current fraud prevention best practice is to identify key risk indicators on operational risk and background checks and compare with other assessments of level of transparency and risk disclosures. Rigorous profiling is essential, as is the need to revisit individual assessments annually or bi-annually.
Posted by James P Tunkey at 09:16 PM | Comments (0) January 07, 2009 On Madoff and DangerfieldIn mid-December, I was in DC talking with a pal who, like me, specializes in the conduct of due diligence on behalf of potential investors. We swapped stories about Drier and Madoff. The careful ones who did a bit of due diligence, chose to pass and survived. I recall a conversation back to a year previous, when I watched a bit of tennis in Queens with a CRO of a major pension fund. Things were unraveling in autumn 2007 and the CRO was reviewing risk management strategies of top tier managers in which the fund had invested. High profile names. Yet there had been no previous due diligence in the many years the hard sweat and labor of a respected and humble working class had been injected into these purportedly luminous funds. The reason why? We are lucky they are taking our money to earn us these returns. We do not want to upset anybody by asking tough questions. Another note from the front. Also in December in NYC I was speaking with a group of CROs and amidst a crescendo of cries that CROs get no respect one CRO at the table stated he knew many of the complex structured financial instruments his institution was working with into 2008 were deadly toxic but what was he going to do, quit as a matter of principal? All of this would be so very Caddyshack if you did not have to read the cries for help from Madoff investors and their families that Bloomberg was posting the day after his arrest. Thank heavens Itzhak Stern, accountant with Oskar Schindler, was not doing Rodney Dangerfield impersonations. Those are my principles, and if you dont like them... well, I have others. - Groucho Marx The only thing necessary for the triumph of evil is for good men to do nothing. - Edmund Burke Posted by James P Tunkey at 02:48 PM | Comments (0) November 03, 2008 The ExcommunicationShining tempters formed of air, symbols of desire No recent economic congressional testimony was perhaps more shocking than former Federal Reserve Chairman Alan Greenspans. The 82 year old Oracle states his world view was flawed. Thunderous shock echoes out the Manhattan canyon and past New Jersey to Japan like a bad Saul Steinberg New Yorker magazine cover. The clatterers pile on, the noise deafening, culminating in Alan Greenspans excommunication by the Ayn Rand Center for Individual Rights. From Greenspan: An infectious greed seemed to grip much of our business community. From Rand: Since time immemorial and pre-industrial, greed has been the accusation hurled at the rich by the concrete-bound illiterates who were unable to conceive of the source of wealth or of the motivation of those who produce it. I am going to put a thumb on this event for the future. Underlying assumptions about component motivations of the architects and inhabitants of a (risk management) worldview is worthy of future reference. Is greed easier to finger than complexity? Posted by James P Tunkey at 03:00 PM | Comments (0) September 19, 2008 Pursuit of Absolute Risk MitigationIn governmental organization the costs of preventing or reducing corruption are not balanced against the gains with a view to finding an optimal investment. Instead corruption is thought of (when it comes under notice) as something that must be eliminated no matter what the cost. Edward C. Banfield, Corruption as a Feature of Government Organization, 1996. ----- United States Department of the Treasury Secretary Henry Merritt Hank Paulson has fired AIG CEO Robert B. Willumstad, after a week in which Lehman Brothers has fallen, and mother Merrill has been married off again. There is no lack of irony that AIG, which had avoided nationalization by Mao by leaving Shanghai in the 1940s, found itself taken over by the United States under 43. Each day on television, leading government and industry authorities are calling for better risk management, and the failures of the financial system are being woven into Main Street conversations. This week in Atlanta, as I witnessed a couple discuss debt insurance and government bailouts over breakfast at a table next to mine, the pendulums bob reached its peak, lost velocity, and began to swing in the other direction. Everywhere pundits are calling for better risk management but as the opening quotation from Anechiarico and Jacobs' case study The Pursuit of Absolute Integrity, How Corruption Control Makes Government Ineffective shows, better risk managagement is not the issue. The FBI is investigating fraud. In New York, risk managers working at financial institutions are fully engaged in battle, managing an environment that shifts daily, and too busy to do anything else. Registration for an upcoming Operational Risk Forum put together by PRMIA New York Steering Committee member Philippa Girling is only a fraction of what it was last year, despite a terrific program (see below). In Washington, regulators are just digging in to the buffet. A similarly structured Forum (see below) slated for Monday organized by PRMIA Washington Regional Director Christopher Whalen has enjoyed record pre-registration. With the pendulum now swinging in the other direction, it is important to keep perspective on where we are headed. 1) Elimination of risk comes at the cost of growth. This summer I managed a team of nearly 90 people who undertook threat assessments and prepared risk management plans (incl. evacuation plans) in advance of the 2008 Beijing Summer Olympic Games. This team went on to provide executive protection to VIPs, operate a 24-7 Security Operations Center where emergency calls were managed, and provide other liaison services to members of the Olympic Movement. While Beijing was observed to have done an excellent job of reducing the likelihood of a recurrence of bombings that occurred in Atlanta around the 1996 Summer Olympic Games (by securing the Olympic Green and key routes on opening night with over 200,000 army officers covering within eyesight of each other, and in the nights thereafter with a significant local law enforcement presence) or 1999 riots at the WTO Ministerial Conference in Seattle (by enhancing control over secure protest areas to include background screening of applicants), they came at a cost of discourse and innovation (empty protest areas) and lost revenue (low attendance within the Olympic Green). 2) A regulatory approach to the process of risk management (and institutions that take risk will be ineffective. As Felix Nigro stated in Public Personnel Administration (1959): Waging this type of battle becomes a habit that tends to continue long after the enemy is routed or voluntarily retires. Since civil service appropriations tend to be limited in the first place, concentrating resources on combating an imaginary foe means neglecting the development and expansion of urgently required or highly desirable activities, such as more vigorous recruiting, personnel research, and training. Overlapping regulatory and enforcement regimes were unable to correct what the Daily News a blatant disregard for even the most basic fire safety rules in advance of the tragic 2007 fire at 130 Liberty Street. New Yorks bureaucracy (one of only six in America at the time with relevant focus and structure) was also unable to address construction site risks that lead to high profile construction crane collapses; as a result of failures by operators to comply with manufacturer specifications or properly train employees about job site hazards while allowing these hazards to exist. ----- As promised here is a record of the scheduled forums, followed by Merriam Websters definitions of odds and risks. ----- DC Opening Remarks by Chris Whalen, Institutional Risk Analytics, PRMIA DC Steering Committee Panel I -- 9:15-10:30 -- Adding Value Through Operational Risk Management: Andy Leonard, SVP, Fannie Mae; Mike Yamamoto, MVP of ERM, Capital One; Aniruddho Sanyal, SunGard; Jan Voigts, FRBNY; David Cox, Deloitte (Moderator) Panel II -- 10:45 -- 12:00 -- Op-Risk & the Payments System: Determining Risks and Mitigating Exposure: Hans Cobben, SunGard; Victoria Garrity, FRB Boston; Hugh Kelly, KPMG; Alfred Seivold, Federal Deposit Insurance Corp (Moderator); Luncheon -- 12:00-1:45 * Introduction by Syed Ahmad, Federal Housing Finance Board, PRMIA DC Steering Committee * Keynote address by Ali Samad-Khan, Principal, Towers Perrin Changing the Risk Management Paradigm Panel III -- 2:00-3:30 -- Financial Institution Security in the Age of State-Sponsored Terrorism: Celina Realuyo, National Defense University; James Routh, Depository Trust & Clearing Corp; Gary Owen, SVP, Citigroup; James P. Tunkey, Director-Americas, IONASIA/PRMIA NY Steering Committee (Moderator). Concluding Remarks Reception ----- NEW YORK Feature speakers include: -----
Posted by James P Tunkey at 05:49 PM | Comments (0) May 20, 2008 Etrange Amour: How I Learned to Stop Worrying and Love Traders"[Clemenceau] said war was too important to be left to the generals. When he said that, 50 years ago, he might have been right. But today, war is too important to be left to politicians. They have neither the time, the training, nor the inclination for strategic thought." Dr. Strangelove; Kubrik, George, et.al. Societe Generales Euro 4.9 billion loss at the hands of Jerome Kerviel is old news that will be coming back into the headlines in the days ahead. While SocGen has a new leadership team in place and Kerviel has moved on, the official autopsy will be published on the 25th. In a recent conversation with a Soc Gen OpRisk insider (Segoi), Segoi highlighted aspects of a Strangelove-ian cultural legacy. "Traders were not supposed to be questioned.'' Not only was there, says Segoi, ''a lack of controls'', but also ''a culture that would not allow you recognize them''. Reminds me of the following exchange: President Merkin Muffley: General Turgidson, I find this very difficult to understand. I was under the impression that I was the only one in authority to order the use of nuclear weapons. Segois following comments are eerily similar: ''Kerviel is reported to have made money for the bank in previous years. Who likes to question whether todays profit is likely to become tomorrows extreme loss?'' Perhaps the lesson is a scenario: Participants: board rep, president, risk committee, major business unit heads, back office. Requirement: Identify a profitable business unit, preferably in one or group of second tier jurisdictions. Identify weak control functions, or functions where a new robust control mechanism has been recommended but where financial constraints have limited the firms ability to pursue. Background: List your last two most recent internal crisis that have incurred heavy losses / required corporate blood and treasure to recover, consider how response to past has affected expenditure on new controls – addressing current/future problems. Scenario: A subordinate of profitable business division X is exceeding controls, potentially driving the firm to deal with nuclear fall-out. Be creative about how it could occur in your business. Task 1: Value the potential expense: (a) loss, fines, litigation, reactive controls improvements, old leadership payouts, new leadership retention, reorganization, reactive enhanced technology investments that raise a variety of privacy and ethical issues, and other costs. Task 2: Determine what preventative measures would be cost effective risk mitigation. Task 3: Identify what authorities and mandates work at cross purposes to this. Posted by James P Tunkey at 08:24 PM | Comments (0) April 06, 2008 THE (DATA) PIN FACTORYAdam Smith was the worlds greatest magician. In the Wealth of Nations, you learnt how the trick (division of labor creates global capitalist economy) was constructed, but got to still be amazed when it actually worked two hundred plus years later. I have landed on Father Adam after gathering quotes on data quality (below) and data manipulation over time. The evergreen problem of twisting and tainting data for personal gain is certainly tied to subprime. And it would be fun to stop there and point fingers. If you were looking to do so, I highly recommend using the Til Schuermann February 2008 presentation to the PRMIA Credit Risk Forum in New York as a reference. He provided a spot-on breakdown of the production process of a subprime mortgage backed security as involving eight groups tied together by deadly frictions that included: predatory lending, mortgage fraud, adverse selection, principal/agent [conflict], model error, and moral hazard. (See reference below.) But its not the frictions specific to MBS that are useful for future reference. It is that we are increasingly dependent on a small division of the population to get the process (of reliable data production and delivery) right. When the trick turns nasty, ever larger proportions of the population suffer. Good operational risk management requires in-depth knowledge of how data is being manufactured and used.
“Managed earnings was an important engine of the system, and its goal, at least implicitly, was to raise corporate stock prices whether or not increases in intrinsic corporate values were achieved.” John C. Bogle, The Battle for the Soul of Capitalism, November 2005 "In 1983, the Bureau of Labor Statistics [BLS] was faced with an awkward dilemma. If it continued to include the cost of housing in the Consumer Price Index, the CPI would reflect an inflation rate of 15%, thereby making the country's economy look like a banana republic. Worse, since investors and bond traders have historically demanded a 2% real return after inflation, that would mean that bond and money market yields could climb as high as 17%… The BLS's solution was as simple as it was shocking: exclude the cost of housing as a component in the CPI, and substitute a so-called 'Owner Equivalent Rent' component based on what a homeowner might 'rent' his house for… While the BLS was correct in assuming that this statistical ruse would fool the average citizen into believing that inflation was only 2% (and therefore be willing to accept a meager 4% return on his bank savings), what is remarkable is that the ruse also fooled the bond traders…” Professor Robert Hardaway, University of Denver Sturm College of Law, September 2007 1) http://www.prmia.org/Chapter_Pages/Data/Files/2154_2848_Til%20Schuermann_presentation.pdf Posted by James P Tunkey at 03:28 AM | Comments (0) March 07, 2008 Getting Back Alive from Subprime: Product Design, Creation Risk & Disaster Recovery CommentsGetting Back Alive from Subprime: Product Design, Creation Risk & Disaster Recovery Comments "The board concluded "that the accident was not the result of a chance malfunction in a statistical sense, but rather from an unusual combination of mistakes, coupled with a somewhat deficient and unforgiving design." NASA, Report of Apollo 13 Review Board, p. 5-1. "The total Apollo system of ground complexes, launch vehicle, and spacecraft constitutes the most ambitious and demanding engineering development ever undertaken by man. For these missions to succeed, both men and equipment must perform to near perfection. That this system has already resulted in two successful lunar surface explorations is a tribute to those men and women who conceived, designed, built, and flew it... Perfection is not only difficult to achieve, but difficult to maintain. The imperfection in Apollo 13 constituted a near disaster, averted only by outstanding performance on the part of the crew and the ground control team which supported them." Ibid., preface.
Today, the world watches as a financial version of the recovery after the aborted lunar landing by Apollo 13 plays out. It is certain that the mission of increasing home ownership for lower income families through new (profitable) financial products has failed. Likewise other short and medium term instruments have failed to fulfill their missions. It remains unclear whether Washington's fiscal and monetary reactions will produce the desired effect. The Main Street solutions don't really address some of Wall Street's biggest problems - the complete collapse of markets for some instruments. Yes, resolution of stress on monoline insurance companies is key. But where is the Odyssey for us to crawl into and return to earth? Paulson's Super-SIV wasn't it. If another exists and we're returning to Earth, why doesn't Main Street feel it? If such a product (suite) does not exist, how can it be designed and implemented in a manner that gives both Wall and Main Street confidence? Indeed, if now is the time to lock the doors and bang (engineer's) heads together - why is there so much movement amongst Wall Street risk managers, with CROs coming and going at such a high rate and whole teams being shifted or shut? A few notes for future reference: (i.) Who can we get involved in product design? (ii.) Where does design expertise and data on new products get housed? Who keeps responsibility for knowing what is inside (of a specific instrument)? Are today's themes of "I thought I had no exposure to subprime" and "I don't know what's inside" ones we seek repeated? What is the value to the enterprise of keeping the original product design team on staff to sort out eventual problems - how should this affect compensation? (iii.) How are financial rewards / incentives examined to identify potential stress points? While subprime litigation is mostly focusing on sales tactics (worth remembering) and fraud, multiple tiers of participants - both vendors and employees - have each had a variety of incentives. Subprime had a complex group seeking reward off a small available % premium. What process would better ensure transparency of motivations - and flaws? (iv.) Do we need to achieve and maintain perfection for this to work? (v.) What is our escape route? Posted by James P Tunkey at 09:18 AM | Comments (2) February 22, 2008 Sovereign Wealth Funds - ERM & OpRisk CaveatsThe US$20 billion in fresh raised by distressed financial institutions post Credit Crunch, with plenty from Sovereign Wealth Funds (SWF), has generated some interesting Operational Risk challenges for the institutions involved. Executive Culture "Revolutionaries do not make revolutions. The revolutionaries are those who know when power is lying in the street and then they can pick it up." Hannah Arendt Although SWFs are being billed to the U.S. Treasury and Congress as "passive", the second law of thermodynamics tells us that the walls barring influence by SWFs will naturally decay over time. For those with short memories, it was only back in 2002 when Slate and others were profiling Sandy Weill´s "cage match" against such Chinese walls. (N.B. Weill is now amongst the latest sources of fresh capital for Citi. Who says history can´t repeat itself?) These walls between SWFs and the executive suite could come down rather quickly. SWF Home Turf: Culture Drag / Lift "We control fifty percent of a relationship. We influence one hundred percent of it." Barbara Colorose How you read this quote depends on where you sit. As suggested above, I believe that it is reasonable to expect that SWFs will at least influence the operations of the Institutions on their home turf (especially if the bailouts lead to to strategic alliances and joint ventures with these SWFs). This influence can be positive or negative. Politics aside, there are clear OpRisk hotspots: from employee relations; to product design and client selection; systems continuity, and process management. Here it is worthwhile referencing the 2007 Globalization Index Rankings prepared by AT Kearney for Foreign Policy (higher numbers denote less economic integration, personal contact, technological connectivity, and political engagement, and the USA is currently ranked 7th): Bear Stearns China (66) Deal Flow www.slate.com/id/2074372
Apart from providing much needed capital, SWFs certainly create new opportunities for deal flow. We see plenty of positive statements made by firms to the media about these opportunities already. But is all deal flow created equal, and how will SWFs alter firm strategy – especially concerning investment of an institution´s resources? The country rankings on Transparency International´s Corruption Perception Index (higher numbers denote more perceived corruption, and the USA is currently ranked 20th) suggest that there are different exposures to corruption (fraud) risk in deal flow: Bear Stearns China (72) Corporate Travel Security It will be necessary for Moses to go to the Mountain, and for executives to pay homage to their new SWF investors. Some countries are more secure than others. Here is a ranking of countries based on the likelihood of a "macro–terrorism" (car bomb or bigger) attack occurring, provided by Risk Management Solutions (RMS). Again a higher number is an increased likelihood. Patronage & Political Risks "I would argue that one of the issues which the public should be much more emphatic about with all politicians... is patronage, appointing people to high positions because they supported your campaign or helped you raise money." John Hickenlooper http://www.transparency.org/policy_research/surveys_indices/cpi/2007 As a coda: SWFs are managed by professionals appointed by national rulers. They are therefore subject to changes of political fortune. One can imagine a range of scenarios that would threaten the constituencies that support various SWF managers. Posted by James P Tunkey at 05:30 AM | Comments (0) About James TunkeyJames Tunkey is an Asia specialist with 15 years of experience assessing risks in the region and in less economically developed countries worldwide. At I-On, James develops and supports the CEO and international office heads implement corporate strategy, while also heading the company´s risk and security consultancy practice in the Western hemisphere. His responsibilities include the oversight of projects conducted on behalf of American clients overseas. James has advised the chief risk officers, chief investment officers, and corporate counsel of Tier-1 financial institutions, hedge and Ivy League pension funds, energy companies, and manufacturers of high value goods from pharmaceuticals to communications equipment. This advice has often been informed by groundbreaking primary research James has conducted of the frequency and impact of operational risk events (e.g., fraud, intellectual property theft, terrorism, natural disasters, corruption) that have occurred in Asia since 1945. It is also informed by James´ expertise leading major inquiries into (i.) State sponsored theft of technology (ii.) multi-billion dollar frauds at public and private institutions and (iii.) the ties of military and organized crime to business. Prior to being assigned to New York, James lived and worked in Asia for 12 years. While in Asia, he completed his B.A. in Chinese Studies at the University of Buffalo´s language program at Capital Normal University in Beijing. While there, he earned his M.B.A. through TRIUM, a joint program of NYU Stern School of Business, London School of Economics and Political Science, and HEC School of Business in Paris. While still in Asia, James also was a participant in the United Nations sponsored Corruption Control & Organizational Integrity Program at the John F. Kennedy School of Government, and Hong Kong University´s Advanced Law Enforcement Interviewing Techniques Course. James is conversant in Mandarin, a Permanent Resident of Hong Kong, and has extensive experience covering East Asia. James is a Certified Fraud Examiner (CFE). His affiliations include: » Professional Risk Managers International Association New York Chapter Regional Director, and former Hong Kong Chapter Regional Director Posted by James P Tunkey at 05:28 AM | Comments (0) |
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