THE PRACTICE OF RISK MANAGEMENT HAS LET ME DOWN. HAS IT LET YOU DOWN TOO?

By Dwayne Strocen
Website: https://www.genuinecta.com

I know you're wondering how the industry and practitioner's of risk management have let me down. I suppose I should begin by telling you that I've been in the industry for more than 15 years, but not as an analyst or modeller. My world is on the other side of risk management, namely risk execution known to professionals as hedging.


I have managed hedging portfolio's for both hedge funds and corporations. Now you'd think that risk management professionals would know what hedging is all about and how it is an integral component of all risk management programs. I'm going to assert that this assumption is flatly false.


If you work for a large corporation or financial institution such as a bank or insurance company you know that there is both a risk management department and a hedging department. Often these two departments are operated as separate and stand-alone entities. Often on different floors and at times in different buildings altogether. The hedging department is usually co-located with the trading department. My question is why?


Small and mid-size companies neither have a full time risk management department and usually no derivatives expertise.   A good deal of these part-time duties are assigned to a department called Treasury with oversight by the Chief Financial Officer who's usually an accountant. The Treasury department is a catch-all for everything not sufficiently large enough to have its own management oversight.


Why is risk management oversight headed by the chief accountant when in fact the COO, Chief Operating Officer is much better suited for this task. Risk management and hedging is more closely related to a company's operational requirements than it is to accounting and auditing. But I can't fault the executive committee for making this error. After all what do they know about risk management and its different components.


As a risk management and derivatives strategist, our firm usually receive a request from a clients executive team when they realize they have a risk to their foreign exchange exposure or to a rise in interest rates. The question often comes in the form of an assessment to this risk. As a risk consultant working worldwide but primarily in North America, we are often required to source local risk analysts and modellers whom we can imbed within the company to conduct a comprehensive risk assessment. We then compile the analysis and present it to the executive committee or Board of Directors. This will always include a recommendation for a solution to the mitigation (hedging) of their risk.


As any executive or military commander will tell you, never make an analysis or recommendation without including a solution to the problem.  In the field of risk management this ultimately includes the use of derivatives for a comprehensive hedging solution.


Now here is where my problem and criticism lay within the industry. After 15 years, when assessing an analyst candidates knowledge, I have learned to rely on the answer to one simple question. And ninety-nine out of a hundred times the conversation goes like this:


Me: "When you have completed a detailed analysis and present your findings, what is your recommendation comprised of?"

Analyst: "What do you mean?"

Me: "All proposals must include a recommendation for the implementation of a solution, a risk mitigation program. You can't simply submit your analysis without a solution. pause - can you?"

Analyst: "I really don't understand your question?"

Me: "What do you do after the completion of your analysis?"

Analyst: (confused look) "Well, more analysis."

Me: "Okay, let me re-word the question. o you ever recommend the use of hedging in the final presentation to your boss or client?"

Analyst: "What's hedging?"

Sigh, end of interview…


Over the years, I've heard all sorts of the excuses from risk analysts to justify their position:

• I'm just an analyst / modeller;

• I don't work in hedging;

• I'm not a trader;

• in my previous position I did not have to know that;

• isn't hedging part of the trading department;

• hedging isn't risk management;

I's akin to a Dentist saying "we only conduct examinations here, you'll have to find another dentist to pull your tooth."  A mechanic saying "We don't fix cars here, only assess the repairs you might need". A roofer saying "I only install new shingles, you'll have to get someone else to remove the old ones."


It sounds silly, but don't laugh. About as silly as a risk management professional saying "We only conduct analysis here, you'll have to find someone else to manage the risk execution program." Then insult the client and the profession even further by saying "I can't help but I'm sure you can find someone on the internet."


Is the client or employer receiving value when presented with an incomplete recommendation. They deserve to have every opportunity to make an informed decision with all the information available. In a time where companies are becoming more competitive, more complex, more things to their customer base in order to survive. It's time the risk management profession does the same. It's time to recognize and embrace risk management as a two step process.

-   Step one – The analysis phase;

-   Step two – The execution phase;


Now let me make a recommendation of my own. whether you're a consultant or a department head you can add value by including a derivatives specialist with expertise in hedging and risk management. But please don't look your client in the eye without the courtesy of a comprehensive proposal which includes the execution phase of risk management. Hedging.


Dwayne Strocen is President of Genuine Trading Solutions Ltd. a registered CTA firm and derivatives strategist specializing in analyzing and hedging market and operational risk using exchange traded and OTC derivatives.