Developing Issues: FX Managers’ Agenda; Risk Outlook from Davos and What Caused the Financial Crisis?

January 27, 2011

What’s on International Treasurer’s radar screen this week.

In this week’s editorial discussion we addressed outcomes from the recent agenda-setting call for The NeuGroup’s two FX Managers’ Peer Groups’ “summit” meeting coming up in March, the usefulness of the Davos World Economic Forum for identifying emerging risks and troubles policymakers are having in digesting what caused the recent financial crisis.

What’s on FX managers’ agenda?
The top issues looking to make the agenda for the upcoming FX Summit include:

  • Hedge-decision methodology, where members hope to identify scalable decision-making processes for when exposures grow in number, and to draw appropriate lines for what types of exposures can be processed using a more systematic approach vs. those exposures that need more hands-on consideration, i.e., algorithm-based vs. committee decisions;
  • How FX teams should best measure their performance and their value-add to their companies: to tackle this topic, members will dissect qualitative and quantities measures for both operational and corporate-level hedging;
  • Hedging with options, where practitioners will seek to refine their business case for using options in the this era of continuing volatility along with a more systematic approach to using them; and
  • Updates on how the Dodd-Frank financial reform regulations will be made concrete in the rule-making process and shared views on how this will affect their activities going forward.

Risk Identification at the World Economic Forum
Short of actually attending the event, the World Economic Forum in Davos and the reports coming out of it are a useful mechanism to validate agendas and indentify emerging risks. As an example, we are reading the 60-page Global Risks 2011 report, which provides a high-level overview of 37 selected global risks as seen by members of the World Economic Forum’s Global Agenda Councils and supported by a survey of 580 leading global decision-makers. The report also includes input from the World Economic Forum’s Global Risk Partners: Marsh & McLennan Companies, Swiss Reinsurance Company, Wharton Center for Risk Management, University of Pennsylvania, and Zurich Financial Services.

What caused the financial crisis?
The release of the US Financial Crisis Inquiry Commission’s (FCIC) report has prompted yet another round of debate on what actually caused the financial crisis that nearly brought down the global system in the fall of 2008. There are apparently multiple views within the Commission and a number of people outside it that believe the root causes were not even addressed in the consensus or dissenting sections of the report. In all likelihood, as an Op-Ed in the Wall Street Journal from three of the dissenting Commissioners argued, there were a variety of contributing factors. This is consistent with some of the takeaways from discussions in The NeuGroup’s Corporate ERM Group, which emphasize that big, take-down-the-firm, or take-down-the-system, risks are often best viewed as the cascading impact of multiple risks or exposures hitting either at once or in just the right sequence. Thus, risk managers along with policy-makers hoping to avoid such a crisis from occurring again have to do a better job of emphasizing vulnerabilities to known risks that come at them in unexpected patterns, as well as the unforeseen risks. The chief lesson of the crisis seems to be that risk-takers as well as regulators fail to act when the cost of action appears dearer than the exposure to any flagged risk viewed either in isolation or in the context of expected outcomes.

But how do you know when to act before a cascading effect leads to systemic crisis? To some risk managers, the only way to do this is to build resiliencies or redundancies into their systems so that they can withstand a multitude of scenarios. Total invulnerability is impossible, not to mention uneconomical, so the compromise is to maximize the risk resiliency created for every dollar allocated to risk management and shift resources to resiliency maximization when risks and risk sequences flagged as potential firm-busters appear on the radar screen. The FCIC report might be more useful if it pointed out how those that failed the system might have made it more resilient as each of the contributing causes that many knew about before 2008 increased vulnerability.

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