On Sunday I posted about one of my many experiences in Helsinki last week - so now here’s an snippet from a talk I gave to a C Level event for IBM in New York last week as well.
At some point during the day, an IBM executive shared some startling data from a survey they had conducted of CFOs. 62% of these folks said they were affected by a major risk event in the last year and 43% of those said they were “ill prepared.”
For sure the global economy and complex, high metabolism business world is bringing new sources whereby companies can suffer loss - the sub prime mortgage crisis being a case in point. But still, anyway you slice it, 43% being ill prepared sure sounds like an opportunity.
This wasn’t, however, the first time we’ve seen this issue pop up, and in a recent discussion with executives at the risk management Algorithmics, we began to explore the implications of wikinomics for managing financial risk. While I can’t go into all of the details, the jist of it can be summed up as follows:
Hypothesis: many of the biggest sources of risk come from lack of transparency and sharing of intellectual property among stakeholders in financial marketplaces. If companies in financial services and beyond were to adopt the principles of wikinomics, peering, openness, might we avoid the tsunamis of risk that affect us all and are on no one’s interest? Could we open source a big part of financial risk management? Might a risking tide of cooperation lift all boats, leaving us to compete on a higher, but more stable water level?
I am so struck by the huge possibilities of this idea that we are launching a research project at New Paradigm on the topic. I’m delighted to say that the risk management rocket scientists at Algorithmics are going to work with us.
Open Source financial risk management. If this is feasible it might change the global economy. What do you think about it?
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The Risk Management series that I proposed to Deepak could address this research as one of its topics. If not, I would like to throw my name in the hat.
There is a significant amount of transparency required for financial services institutions by Sarbanes Oxley (US )and Basel II (globally). A well implemented Basel II program was designed to prevent the types of tsunami that recently occurred with the mortage meltdown. However, Basel II is being inconsistently (content and timing) implemented across jurisdictions and risk models (a major input for Basel II) are generally considered proprietary as global banks spend (in sames cases misspent) millions in developing and maintaining them. It looks like the risk models require major rework, as the only investment bank to avoid the meltdown, Goldman Sachs, did not rely on models, but on a savvy executive to minimize the impact.
I spent my last two years at Citi as the Global Technology lead for the Basel II program. I have access to a number of Basel II SMEs, including two of my current associates. One of my major deliverables for Citi was a transparency and traceability framework, as these two powerful concepts are implied by the Basel II accord.
Comment by Edmundo - November 27, 2007 12:16 pm
Edmundo. This sounds like a fruitful collaboration!
Comment by Don Tapscott - November 27, 2007 2:35 pm
Interestingly this is pretty much what the credit card issuers do to handle fraud today. They share data (anonymized) so that models can be developed to predict fraud across issuers. By aggregating their data they can have better models built. All the issuers gain from reduced fraud. Two challenges would seem to apply to apply a wikinomics approach:
- the credit card consortium uses a trusted intermediary to store and process the shared data. This may be necessary for this kind of data
- the issuers decided that reducing fraud was not a source of competitive advantage and so were willing to collaborate for shared benefit. How do you get organizations to see a given problem in this light?
Good luck though
JT
Comment by James Taylor - November 29, 2007 4:57 pm
IFSL research has reported that the nominal value of OTC derivatives has leaped from $50 trillion in 1996 to over $415 trillion today. That’s roughly twelve times the GDPs of the US, the European Union, Canada, Japan, and China combined.
In other words, decades ago the derivatives market moved far beyond being a place to simply hedge risk, but has become to some degree, the world’s largest casino.
The major players in these markets have mathematical models, and computer systems that, in theory, will ensure that losses are contained.
For example, one Wall Street player’s computerized systems work on the mathematical assumption that exceptional downside risks could be managed 99% of the time. The question of course is what happens the other 1%?
More specifically Wall Street’s systems (in my experience) are programmed on the assumption that markets are fluid, and that as the value of an asset falls, that one can sell it at a pre-determined price, thus capping ones potential losses. The fear of course is that on “Black Monday” and other major market retreats, experience has shown that in a free fall attempts to sell at a given price is of little use when everyone is selling.
Orange County’s derivatives-based bankruptcy in 1994, the short-lived experience of Long-Term Capital, are examples of the huge inherent risks that parties can hold, without fully understanding the risk.
Clearly the entrance of private unregulated Hedge Funds, their massive capital bases, and their willingness to highly leverage their capital may as did Long-Term capital threaten the solvency of the entire system.
In the case of Orange County it is clear that those from the county were unaware of the risks, until long after it was too late to mitigate them.
Can further transparency in the marketplace better control the risks? Can crowd sourcing better predict future market behaviors?
Comment by Bob Tapscott - December 2, 2007 7:07 pm
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