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Presentation from a Manigent webinar on - Feb 14 2011.
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Integrating Risk Appetite with Strategy Introducing a integrated risk appetite framework
Prepared for
Manigent webinar14 February 2011
Page 2
Culture and mindset
Risk-based Performance Management integrates traditional
performance and risk management to enable sustainable strategy
execution
Performance Management
Risk Management
Strategy Management
Appetite
What are we trying to achieve?
Are we on track?
What are our Threats and Opportunities?
What is our Risk Appetite?
Are we operating within appetite?
Page 3
The Risk-based Performance Management model is designed to
be a continuous process: the journey is the destination
Operationalise change
Model future uncertainty
Clarify Strategy
Monitor & analyse results
Sustainable Strategy
Define ControlsDefine Initiatives and actions
Monitor and analyse indictors, KPIs, KRIs and KCIs. Capture and analyse risk events and losses
What-if analysisScenario analysisWar games
Define ObjectivesDefine Appetite
Define RisksDefine Drivers
Communicate what could hit us ‘out of the blue’
Communicate intent & accountabilities
Communicate how we will provide assurance whilst
driving change
Communicate where we are doing well & doing poorly
Page 4
Risk Appetite, and more specifically appetite alignment,
is central to the Risk-based performance approach
Risk Appetite is central to sustainable strategy execution
Page 5
Failures around risk appetite were highlighted in governmental
and regulatory post-credit crunch reviews
Supervisors see insufficient evidence of board involvement in setting and monitoring adherence to firms’ risk appetite.
Risk appetite statements are generally not sufficiently robust; such statements rarely reflect a suitably wide range of measures and lack actionable elements that clearly articulate firms’ intended responses to losses of capital and breaches in limits.
Board-level engagement in risk oversight should be materially increased, with particular attention to the monitoring of risk and discussion leading to decisions on the entity’s risk appetite and tolerance.
Remuneration structures for all such “high end” employees are appropriately aligned with the medium and longer-term risk appetite and strategy of the entity.
In essence, the obligation of the board in respect of risk should be to ensure that risks are promptly identified and assessed; that risks are effectively controlled; that strategy is informed by and aligned with the board’s risk appetite; and that a supportive risk culture is appropriately embedded so that all employees are alert to the wider impact on the whole organisation of their actions and decisions.
What is Risk Appetite?
Page 7
The definition of Risk Appetite is clear, but the
application is less well understood
The COSO definition provides ‘What, Who, When and
Why’ of risk appetite
What: the amount and type of risk
Who: an organisational entity
When: over a defined time horizon
Why: to achieve the objectives of the entity
Risk appetite is the amount and type of risk that is acceptable to be taken by an
organisational entity over a defined time period, to achieve the objectives of that entity – COSO Enterprise Risk Management
Risk appetite sets the boundaries within which strategy is executed – Manigent
Page 8
Risk Appetite is a multidimensional construct, which changes
depending on the organisational entity and what they are
trying to achieve
Extreme
High
Moderate
Low
Overnight
90 days
Annual
Cre
dit
Liq
uid
ity
Op
erat
ion
al
Mar
ket
Stra
tegi
c
Investment Banking exampleWe are willing to put £x million of capital @ risk to trade on our own account over the next 12 month period.
We hold no more than x% of our capital in overnight positions.
We will accept operational losses of £x million per month.
Water Industry exampleWe have no appetite for causing customer illness by supplying poor quality water.
We have no appetite for appearing in local press related to leaks or fines for more than 2 consecutive days.
Page 9
Cascading Risk Appetite through the organisation, is a
powerful way of shaping culture and aligning risk-taking
Organisational entity
Income Capital
Organisational entity
Income Capital
Organisational entity
Technology Reputation
The nature of the organisational unit will influence the risk dimensions
used to consider appetite.
Integrating Risk Appetite with
Strategy
Page 11
Risk Appetite should be integrated
into your organisations standard
strategy frameworkBusiness Goals
Business Drivers
Business Model
Internal Analysis External Analysis
Business Objectives
Strategy Management
Appetite Alignment
Initiative Management
Compliance
Risk ManagementPerformance Management
Appetite
Identify strengths & weaknesses
Identify threats & opportunities
Is our business model fit for
purpose?
Is our business model fit for
purpose?
Are we operating within appetite?
Manage threats & opportunities
Are we on-track to deliver?
Manage strengths & weaknesses
Appetite
Sett
ing
Exec
uti
on
Form
ula
tio
n
SettingFrom high-level strategies to specific business objectivesDefine specific business objectives and appetite for specific entity’sAllocation of scarce resources by entity, risk category, product lines
ExecutionAre we on-track to achieve our business objectives Are we operating within appetite (are we taking too much, or not enough risk?)Do we have the right level of controls in place to meet internal and external compliance drivers?Are we aligning our change agenda to our strategic agenda?
FormulationDevelopment of high-level strategies and allocation of scarce resources, including capitalGiven our business context, what is our appetite for risk? Given our appetite, have we got the right business model?Are we comfortable with the assumptions we have made?
Page 12
Risk Appetite has multiple touch
points within the overall strategy
processBusiness Goals
Business Drivers
Business Model
Internal Analysis External Analysis
Business Objectives
Strategy Management
Appetite Alignment
Initiative Management
Compliance
Risk ManagementPerformance Management
Appetite
Identify strengths & weaknesses
Identify threats & opportunities
Is our business model fit for
purpose?
Is our business model fit for
purpose?
Are we operating within appetite?
Manage threats & opportunities
Are we on-track to deliver?
Manage strengths & weaknesses
Appetite
Sett
ing
Exec
uti
on
Form
ula
tio
n
Translate the strategy into specific objectives – creating a hypothesis of our strategy Cascade the strategy via business objectives through the organisation Define appetite for each objective, setting boundaries by organisational unit,
strategic theme, risk category or even product line Building into your strategy a hypothesis about the risks required to deliver the
strategy Linking objectives and appetite shapes culture and enables the cascade of the high
level strategy and appetite down to the operational level where it is actually executed.
Monitoring alignment between exposure and appetite enables understanding of Is the business operating within the boundaries set by, or cascaded
from the Board i.e. appetite? Is the business taking too much or too little risk to achieve its
objectives? Monitoring appetite alignment complements existing, commonly used, one-
dimensional tools, strategy and risk maps
• Engage with your shareholders• Determine how your organisation is going to view risk – the dimensions of
appetite• Business drivers inform the choice of dimensions of appetite• Drivers and Appetite influence choice / discussions around the business model• Select the ‘best’ strategy and set the risk appetite – this is where the board fulfil
one of their key responsibilities – setting the boundaries within which strategy is executed
Page 13
Risk appetite should influence the
your business model and help
identify the ‘right’ business modelBusiness Goals
Business Drivers
Business Model
Internal Analysis External Analysis
Business Objectives
Strategy Management
Appetite Alignment
Initiative Management
Compliance
Risk ManagementPerformance Management
Appetite
Identify strengths & weaknesses
Identify threats & opportunities
Is our business model fit for
purpose?
Is our business model fit for
purpose?
Are we operating within appetite?
Manage threats & opportunities
Are we on-track to deliver?
Manage strengths & weaknesses
Appetite
Sett
ing
Exec
uti
on
Form
ula
tio
n
Business ModelThe rationale of how an organisation creates, delivers, and captures value - economic, social, or other forms of value. Different business models have different inherit risk/reward characterises.
Business Models are being challenged in many industries by; Increasing and changing regulation Corporate and personal de-leveraging Tight credit conditions On going globalisation Rapidly changing technology
Business Model
Capture value
Create value
Deliver value
Page 14
Business drivers play a critical
role in the strategy process, and
in this risk appetite frameworkBusiness Goals
Business Drivers
Business Model
Internal Analysis External Analysis
Business Objectives
Strategy Management
Appetite Alignment
Initiative Management
Compliance
Risk ManagementPerformance Management
Appetite
Identify strengths & weaknesses
Identify threats & opportunities
Is our business model fit for
purpose?
Is our business model fit for
purpose?
Are we operating within appetite?
Manage threats & opportunities
Are we on-track to deliver?
Manage strengths & weaknesses
Appetite
Sett
ing
Exec
uti
on
Form
ula
tio
n
Business DriversThe critical factors that determine the success or failure of an organization's strategy and its ability to deliver shareholder value.
Objectives
Risk Appetite
Scenarios
Key Risks
Business drivers Shareholder value
Risk Exposure
Risk Dimensions
Capital
Income
Reputational
Regulatory uncertainty
Share price
Economic Value Add
Return on risk adjusted capital
Return on risk adjusted assetsRisk Events
Technology innovation
Business Driver Relationships Drivers help determine the ‘right’ Business Objectives, their KPIs
and targets. Select the ‘vital few’ drivers to use as risk dimensions to define risk
appetite Assess risk using the same dimensions Link risk events back to drivers to provide powerful strategic
analytics Use business drivers as a base for scenarios to test and validate the
objectives and risk appetite Major changes in business drivers may lead to changes in not only
objectives and risk appetite, but at the most extreme, to the whole business model.
Page 15
This Risk Appetite framework is based on a ‘vital few’ drivers which
shape thinking around risk appetite and how risk is assessed, and
creates a ‘hard’ link to strategy
Objectives(What are we trying to achieve?)
Risk Appetite(How much risk do we want/
need to take?)
Scenarios(What could go wrong/right?)
Key Risks(What are our uncertainties related to achievement of the
objectives?)
Business drivers Shareholder value
Risk Exposure(How much risk we taking?)
Risk Dimensions(How do we think about risk)
Capital
Income
Reputational
Regulatory uncertainty
Share price
Economic Value Add
Return on risk adjusted capital
Return on risk adjusted assets
Risk Events(What has gone wrong/right?)
Technology innovation
What determines success?
How to define success?
Page 16
When considering risk appetite, the Board and Executive should
also develop a clear understanding of the organisational Risk
Capacity
Risk Capacity is the absolute maximum amount of risk an
organisation can withstand without causing its failure.
Low Moderate High Extreme
Risk Appetite Risk Capacity
Take emergence action to reduce risk,
and get back into appetite
Put the resolution plan into action to
wind up the business
Risk Appetite and Risk Capacity
Page 17
Using this approach enables the Board to be very clear
about the operating boundaries for the business
This approach creates shared, clear and actionable understanding of the organisational
appetite, within the Board, the executive and across the enterprise.
Using clearly defined risk dimensions and levels of risk, creates a common language for
the organisation, at all level, to embed risk in a strategic or operational decision-making.
Risk DimensionTime
horizonLow Moderate High Extreme
Capacity Limit
Capital OvernightX% Capital
@RiskX% Capital
@RiskX% Capital
@RiskX% Capital
@RiskAbove X £M
Capital AnnualUp to X £M
X £M to Y £M
X £M to Y £M
X £M to Y £M
Above X £M
Reputation AnnualUp to X vol. Bad coverage
Up to X vol. Bad coverage
Up to X vol. Bad coverage
Up to X vol. Bad coverage
Page 18
The Risk Assessment process is driven by the risk
dimensions used to define risk appetite enabling exposure
to be aligned to appetite
Capital @Risk
Reputation @Risk
Impact x Likelihood (over a time horizon)
Appetite sets the boundaries for the business within which they execute strategy and create value.
Therefore the Appetite Alignment Matrix provides a method of visually monitoring and managing our risk taking according to the strategy, identifying where too much or not enough risk is being taken.
Page 19
How this approach fits together to enable Boards and
Executive teams to answer some ‘big’ questions.
Business Model
Capture value
Create value
Deliver value
Objectives
Risk Appetite
Scenarios
Key Risks
Business drivers Shareholder value
Risk Exposure
Risk Dimensions
Capital
Income
Reputational
Regulatory uncertainty
Share price
Economic Value Add
Return on risk adjusted capital
Return on risk adjusted assetsRisk Events
Technology innovation
What is our business?
What is our Strategy?
What is our risk exposure?
How do we think about, and what is, our appetite ?
Are we operating within Appetite?
Setting Risk Appetite
Page 21
Risk Appetite Setting process
This process is designed to quickly establish the organisational boundaries – risk appetite.
Step 3 can be combined with either step 2 or 4.
Splitting the workshops in step 4 is designed to bring out different views / perspectives, but these can be combined.
1. Joint Board / Executive appetite familiarisation workshop(s)
3. Joint risk dimension workshop(s)
4. Board appetite setting workshop(s)
4. Executive appetite setting workshop(s)
2. 1-2-1 follow-up meetings
5. Joint Appetite setting workshop (s)
6. Joint Board / Executive Appetite sign-off
Page 22
1. Risk Appetite familiarisation
Key deliverables
One 2 hour workshop session
Workshop documentation/notes/report
What does ‘good’ look like?
Full and active participation by the Board and
Executive
Engaging debate demonstrating understanding of
the business value
Answer the question – How does this help us
make money? Create value?
1. Joint Board / Executive appetite familiarisation workshop(s)
3. Joint risk dimension workshop(s)
4. Board appetite setting workshop(s)
4. Executive appetite setting workshop(s)
2. 1-2-1 follow-up meetings
5. Joint Appetite setting workshop (s)
6. Joint Board / Executive Appetite sign-off
Purpose
To ensure the board and executive have a
shared understanding of risk appetite.
Develop a shared understanding of the
problem and proposed approach.
Key inputs
Risk Appetite training pack
Page 23
2. 1-2-1 follow-up meetings
Key deliverables
Meet with all members of the board and
executive
Capture and consolidate feedback/thoughts
What does ‘good’ look like?
All members of the board and executive can
answer the question;
How does risk appetite help us make
money? Create value?
1. Joint Board / Executive appetite familiarisation workshop(s)
3. Joint risk dimension workshop(s)
4. Board appetite setting workshop(s)
4. Executive appetite setting workshop(s)
2. 1-2-1 follow-up meetings
5. Joint Appetite setting workshop (s)
6. Joint Board / Executive Appetite sign-off
Purpose
To enable individual members of the board or
executive to ask questions, seek clarification,
debate the topic, challenge the approach etc.
Build buy-in and support
Key inputs
Meeting guide
Page 24
3. Joint risk dimension workshop(s)
Key deliverables
One 2 hour workshop (additional workshops
maybe required). Alternative approach: Could be
combined with steps 1 or 4
Documented and agreed risk dimensions,
including selection rationale
What does ‘good’ look like?
All members of the board and executive
confidently discuss the business drivers and risk
dimensions
1. Joint Board / Executive appetite familiarisation workshop(s)
3. Joint risk dimension workshop(s)
4. Board appetite setting workshop(s)
4. Executive appetite setting workshop(s)
2. 1-2-1 follow-up meetings
5. Joint Appetite setting workshop (s)
6. Joint Board / Executive Appetite sign-off
Purpose
Develop a common understanding of the business drivers
Determine which if these drivers should be used as risk dimensions
Key inputs
Strategy documents
Value driver models
Board briefing/options paper
Potentially, working examples
Page 25
4. Appetite setting workshop(s)
Key deliverables
Two 2 hour workshop (additional workshops
maybe required)
Documented and agreed risk appetite including
selection rationale per team
What does ‘good’ look like?
Any member of each team can confidently
present their view of risk appetite and the
rationale for setting their limits
1. Joint Board / Executive appetite familiarisation workshop(s)
3. Joint risk dimension workshop(s)
4. Board appetite setting workshop(s)
4. Executive appetite setting workshop(s)
2. 1-2-1 follow-up meetings
5. Joint Appetite setting workshop (s)
6. Joint Board / Executive Appetite sign-off
Purpose
Each team develop their own perspectives
and thinking around appetite
Create challenge and debate within, and
between the two teams
Key inputs
Strategy document
Scenario models
Risk Events / Loss data
Page 26
5. Joint Appetite setting workshop (s)
Key deliverables
Clearly defined risk appetite statement with
agreement on measureable limits
What does ‘good’ look like?
Any member of each team can confidently
present the organisational risk appetite and its
supporting rationale
1. Joint Board / Executive appetite familiarisation workshop(s)
3. Joint risk dimension workshop(s)
4. Board appetite setting workshop(s)
4. Executive appetite setting workshop(s)
2. 1-2-1 follow-up meetings
5. Joint Appetite setting workshop (s)
6. Joint Board / Executive Appetite sign-off
Purpose
Develop a common view of risk appetite
between the Board and Executive
Key inputs
Documents from the step 4
Working models / examples based on output
from step 4
Briefing/Options paper
Page 27
6. Joint Board / Executive Appetite sign-off
Key deliverables
‘Sign-off’ risk appetite statement
What does ‘good’ look like?
‘Signed-off’ risk appetite statement
1. Joint Board / Executive appetite familiarisation workshop(s)
3. Joint risk dimension workshop(s)
4. Board appetite setting workshop(s)
4. Executive appetite setting workshop(s)
2. 1-2-1 follow-up meetings
5. Joint Appetite setting workshop (s)
6. Appetite sign-off (Board)
Purpose
Board to formally ‘sign-off’ on the risk
appetite
Key inputs
Examples of appetite process output, as set
in step 5 – dashboards, appetite alignment
matrix
Page 28
Q & A
Page 30
Engaging Manigent
“Using Risk-based performance has delivered a more
focused, structured Risk framework, enabling us to focus
on the vital few – the number of Key Risk dropped from
120+ to just 10! - Investment banking client
"Coupled with the implementation of a new risk
management framework, significant business benefits
are emerging“ – Source: Annual accounts of a
Financial Services client
“we have seen a reduction in our Value at Risk (VaR)
of 27% in the first three months of using Risk-based
performance & StratexPoint” – Financial Services
client
“we were able to reduce our operational losses by over
to 50% in the first year of using Risk-based
performance” – Investment banking client
www.manigent.com | [email protected] | +44(0)20 7921 0022
Page 31
Contact details
Andrew Smart
Managing Director
Manigent
Email: [email protected]
Blog: www.riskbasedperformance.com
Web: www.manigent.com
LinkedIn: http://uk.linkedin.com/in/ajsmart
Page 32
A final thought....
“the reason that a car has brakes is to allow it to
go faster, and the same [applies to]… business
and risk management.”