More last-second speaker changes followed by the appropriate jokes regarding OpRisk. Moderator/organizer expresses her desire for us to discuss ERM issues across disciplines (insurance, banking, energy sector.)
Six panelists: Dave Ingram, Willis. Stuart Wason, OSFI Canada. Jim Allison, ConocoPhillips. Allan Someone, something regulatory. Bruce Manson, Bloomberg. Dan Rodriguez, Credit Suisse.
Define complexity.
Stuart: Complexity is inherent in the businesses we work with [KR: Non-answer.]
Allan: What does complexity do in the financial world? Creates asymmetries between buyers and sellers when it comes to understanding the risks of products. Complexity isn't inherently a problem, but it has to be understood. In finance complexity usually means opaqueness.
Jim: Complex things are dynamic, interrelated, and changing. Our usual micro-analysis toolkit doesn't work. But complex is not the same thing as complicated.
Dave: Agreed. A complex system is adaptive, which means static controls won't work.
Jim: Right, it hasn't worked so far.
Bruce: You may be able to predict the adaptations based on past history. Also there is *some* methodology behind these trades. We know that because they are priced consistently.
Dan: There's also expected complexity and unexpected complexity. [KR: He seems to be equating complexity with model risk.] There's been a general move now toward simpler products, although the complexity risk certainly still exists throughout the system. Regulatory capital requirements are now higher for more complex instruments.
Discuss the regulatory paradigm shift from rules-based to flexible, complex regulation. What are the consequences? [KR: Moderating is lecturing and misusing "begs the question." Why didn't she just put herself on the panel?]
Jim: We were confused as to why the financial services reform dragged energy in at all. Rigidity in regulating complex systems is a red flag.
Allan: Hunt brother cornered the market on silver, but when it went south, they sold off their other major asset: beef. So unexpectedly we have cattle ranchers being severely impacted by the silver market. Legislation is of course a mess, in part because it happens *after* a crisis. Regulation is always backward-looking. They don't have the tools to do so. This is what the Office of Financial Research is supposed to be able to do, if they can get usable data.
Bruce: Bloomberg sees two types of customers: proactive and reactive. This makes it hard to create regulatory solutions. Bloomberg is trying to come up with data from what the proactive people are asking for in order to answer these questions. It's still backward looking, however.
But what is Bloomberg doing to solve the regulatory data problem?
Bruce: We meet with regulators regularly.
Canada did better during the crisis. Do you have similar problems as the U.S.?
Stuart: We try to stay away from rules and instead apply forward-looking principles. The market is 1/10th the size, which allows the regulators to get very close to the institutions they regulate. ORSA follows this type of philosophy. Firms should be able to explain *how* they make their money. Knowing this is a prerequisite for identifying the risks. Note that as nice as it is to use internal models for setting capital, internal models will become a compliance tool only if they don't reflect the way the firm actually approaches risk.
Dave: Assuming that a capital standard is sufficient for regulation is flawed, because one measure of risk does not work. Institutions will find risks that look good under your single measure, and they will eventually blow up. A formula won't be adaptive enough even for setting capital. I would note that the capital requirements in the U.S. for insurers are pretty low, and no insurers operate at that low a level of capital. So it's something like a hybrid system between rules and free market. Insurance came through the financial crisis fine except for one.
Allan: "Well, Mrs. Lincoln, besides that, how was the play?"
Dan: As much as I like that Credit Suisse came through the crisis well, we have to acknowledge that there was some luck involved. Regulatory interference does have these unintended consequences, though, for instance the "London whale" was part of an effort to decrease RWA.
Allan: Private capital caused the financial crisis.
Dan: Private capital that was encouraged by government policy.
Moderator: You can't absolve the banks, nor can you point to a single source. Pointing fingers gets in the way of us coming together and creating adaptive solutions. [KR: I wonder how she expects to develop solutions without understanding what is causing the problems.]
Moderator switch: Risk management is an art and a science. "Dog and Frisbee" and whatnot. So how can we assess the health of the financial system? [KR: He lectured for several minutes before getting to the question, then was practically incapable of articulating the question. A good example of how it's much more difficult to listen than to talk.]
Dave: Having standards for professionalism with risk managers.
Prior moderator wants to know how we get risk managers to go beyond the minimum requirements. [KR: Isn't that was this conference is for?]
Stuart: We need to consider risks from a number of different perspectives. "What if the earthquake happened *today*? What would you do? How would it play out?"
Jim: The question was "Are we better?" At the system level, I don't think we've learned anything. I think the regulations, especially Dodd-Frank, will increase rather than decrease systemic risk by linking into that system entities that previously would have been relatively independent. At the firm level, I don't know. We have learned to simplify as much as possible, but we continue to re-learn the importance of understanding your counterparties. Especially now as we're being forced into dealing with certain counterparties, which makes liquidity risk a bigger concern. Overall I'm not optimistic that we've learned very much.
Allan: Main lesson is that systemic risk is a situation where the whole is greater than the sum of its parts. Consequently the Feds need the data, they need to analyze it to understand the entire system.
Bruce: We just provide data, as opposed to actually managing risk. From what I've seen, though, more data is needed. I think we're doing better, though.
Dan: TBTF is an obvious moral hazard problem. We can give the Fed more data, more resources, etc., *or* we can eliminate the moral hazard. I recently read a study [KR: I think he said out of MIT.] that concluded that regulation *always* creates more risk. I know aspects of regulation have made aspects of banking safe, but overall I think there is more risk, it's just been pushed elsewhere, where we can't see it right now. Consequently I don't believe that empowering the Fed will stop future crises.
Moderator being a mouthpiece for the old moderator now: we need real-time updated data, and get regulators and industry together to get better data. How can we do that?
Allan: Weather forecasting moved from small science to big science. Finance needs to make that transition. We shouldn't give up. It's possible to get there.
Stuart: Stress testing for systemic risk is now part of most regulatory regimes.
Jim: If the system really is complex, then would analysis like Allan suggests actually work?
[KR: Obviously I'm going to have a lot to say on this later. A very dynamic panel, to say the least!]
End Panel 3.
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