Operational Risk: Volatility of Change...

What is volatility and how could this be an operational risk in your particular institution or organization?

The threat of "Volatility" depends on what is being measured. The stock price. The return on capital. The key is that you want to reduce volatility in most cases.

It scares some people. Long term investors, employees and customers.

Volatility is the standard deviation of the change in value of a financial instrument with a specific time horizon. It is often used to quantify the risk of the instrument over that time period.

Who likes volatility?

Volatility is often viewed as a negative in that it represents uncertainty and risk.

However, volatility can be good in that if one shorts on the peaks, and buys on the lows one can make money, with greater money coming with greater volatility.

The possibility for money to be made via volatile markets is how short term market players like day traders make money, and is in contrast to the long term investment view of buy and hold.

So volatility is in the "eye of the beholder". The point is that some people thrive on it and others are better off with that smooth and predictable future.

Risk in a financial institution is defined in terms of earnings volatility. Earnings volatility creates the potential for loss. Losses, in turn, need to be funded, and it is the potential for loss that imposes a need for institutions to hold capital in reserve.

This capital provides a balance sheet cushion to absorb losses, without which an institution subjected to large (negative) earnings swings could become insolvent.

How much capital is allocated to Operational Risk is a measurement issue. The decisions an institution makes in managing Operational Risks is not risk versus return, but risk versus the cost it takes to avoid these threats.

The key determinant of an institutions risk factor against operational failures is not the amount of reserve capital, it is the performance of management.

In fact, in a few spectacular cases of operational failures, incremental capital would have made no difference to the firm's survivability. It comes back to strategy, safety, security and soundness.

How volatile are your earnings? At the end of the day the question is about management controls and measurement.  What if your measurements were not earnings, but the number of workplace accidents and acts of violence?

How effective are they at mitigating operational risks in the areas of the institution that can't be insured?

Look at places where "Change" is happening in huge volumes and at a rapid pace and you will know where to begin.

Trust Decisions: "Lake Anne to Davos"...

The 2024 Annual Meeting of the World Economic Forum (WEF) in Davos Switzerland kicks off January 15-19. Are you traveling this weekend on your way to attend?

The 54th event theme this year is “Rebuilding Trust”.

On Jan 18 at 11:00 CET the session titled “Technology in a Turbulent World” will include CEO panelists from OpenAI, Salesforce, Accenture and Pfizer.

Why?

Flashback to Reston, Virginia in the 2012-2015 time frame, one of the most brilliant people on the topic of trust was across the table asking for relevant feedback.

While several meetings over coffee at home or near the plaza on “Lake Anne”, together, we were reading some of the early drafts of his anticipated book- “Achieving Digital Trust: The New Rules for Business at the Speed of Light”, byJeffrey Ritter:

“Despite decades of research on organizational trust, behavioral sociology, marketing, artificial intelligence, user interfaces, and human relationships, the vocabulary and tools needed to build digital trust simply do not exist. So, within these pages, I share with you a new portfolio of tools and resources:” (Page 24 / Achieving Digital Trust by Jeffrey Ritter).

The “War on Trust” of information was already on the way in 2012, and yet it was well over a decade since our organizations algorithms were exploring the digital universe.

Each night, downloading terabytes of World Wide Web content, for clients reporting and analysis.

“From the Board Room to our modern day asymmetric battlefield, Jeffrey Ritter’s Achieving Digital Trust will open eyes. It provides us with a reference model that management and software architects have been seeking. The survival of the Internet as we know it is currently at stake. This book provides a look into the transparency of «Trust Decisions» and how ensuring digital truth will shape our global governance for decades to come.” Peter L. Higgins, Managing Director & Chief Risk Officer, 1SecureAudit

And next week in Davos, the global key topic is “Rebuilding Trust”?

Think about who you have trusted in your life. How did it begin? Why does it last?

You just never forget sitting across the table from someone you actually trust.

Talking together face-to-face about topics of interest or working on a new innovative solution to a problem-set for all mankind.

Picture it. Looking at each other in the eyes and asking them: Why do you believe it?

• One person is a high IQ, highly educated international lawyer and Oxford professor on the evolution of the Internet.
• One person is from a small town and a college graduate / athlete, who started in business at the digital dawn, years before the Internet was born.

As we mutually reflect on the past, and imagine the future of our world on Earth as we continue to explore our Moon and beyond, we shall always remember.

At the 2015 World Economic Forum in Davos, Marc Benioff, the CEO of Salesforce observed:

“The digital revolution needs a trust revolution. There has been an incredible shift in the technology industry. . . . We’ve gone from systems of record to systems of engagement and now we are about to move into a world of systems of intelligence. But none of these will retain form or have referential integrity unless the customers trust them. Trust is a serious problem. The reality is that we all have to step up and get to another level of openness and transparency.” (Page 32 / Achieving Digital Trust)

Godspeed!

Global Risk Economy: Follow the Money...

Operational Risk in the global economy is migrating to places that 10 years ago would not have been easily forecasted.

New countries, financial institutions and software technologies have changed the playing field for our risk management executives.

Why is this happening?

One example is the movement of employment to more emerging markets where corporate tax rates are lower and the supply of talented workers with specific skill sets is prevalent.

The simple movement of people and systems to those new countries creates new found risks that may not have been as pervasive in the past for the institution.

Another example is the evolution of new computing platform paradigms such as the emergence of "The Cloud" or “Infrastructure-as-a-Service".

This outsourced IT model not only provides economy of scale in terms of just in time computing power but also the more economical licensing models.

Operational Risk within the confines of the global workplace will continue to follow what countries are attractive and where these people and the systems are now operating from.

Along with this migration of responsibilities of vital corporate processes to other cultures and countries comes the risks associated with potential lack of safeguards, both legally and to the physical protection of key corporate assets.

In the United States, our “True International Economy" explains why there are tens of millions of employees now working for US-based corporations outside the country.

Once you have accepted this fact, your personal risk mindset may also change.

How many U.S. organizations have now moved their Corporate Headquarters to Dublin?

How many American companies now have personnel in foreign countries reviewing online “Social Media” content with the assistance of AI?

"You may have heard the phrase "Follow The Money" in several contexts in the past."

Whether it was Watergate investigations in the 70's or now the 2020’s and the new “Global War in Space”.

The real-time tracking of where money flows, can be a core indicator of where Operational Risk managers need to keep their radar focused and on high alert.

Operational Risk Management (ORM) in the next decade will take on a whole new international meaning and significance than it currently does today.

The risks associated with people, processes, systems and external events will become even more exponential…