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Integrating Risk Appetite with Strategy Introducing a integrated risk appetite framework Prepared for

Manigent webinar 14 February 2011


Risk-based Performance Management integrates traditional performance and risk management to enable sustainable strategy execution

What are we trying to achieve?

What are our Threats and Opportunities? What is our Risk Appetite?

Strategy Management

Appetite Are we on track?

Performance Management

Risk Management

Culture and mindset

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Are we operating within appetite?


The Risk-based Performance Management model is designed to be a continuous process: the journey is the destination What-if analysis Scenario analysis War games

Communicate what could hit us ‘out of the blue’

Communicate intent & accountabilities

Model future uncertainty

Sustainable Strategy

Communicate where we are doing well & doing poorly Monitor and analyse indictors, KPIs, KRIs and KCIs. Capture and analyse risk events and losses Page  3

Define Objectives Define Appetite Define Risks Define Drivers

Clarify Strategy

Monitor & analyse results

Operationalise change Communicate how we will provide assurance whilst driving change

Define Controls Define Initiatives and actions


Risk Appetite, and more specifically appetite alignment, is central to the Risk-based performance approach Risk Appetite is central to sustainable strategy execution

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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.

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What is Risk Appetite?


The definition of Risk Appetite is clear, but the application is less well understood 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

 The COSO definition provides ‘What, Who, When and Why’ of risk appetite    

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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 a multidimensional construct, which changes depending on the organisational entity and what they are trying to achieve Annual 90 days Overnight

Investment Banking example We are willing to put £x million of capital @ risk to trade on our own account over the next 12 month period.

Extreme

We hold no more than x% of our capital in overnight positions.

High

We will accept operational losses of £x million per month.

Moderate Water Industry example We have no appetite for causing customer illness by supplying poor quality water.

Strategic

Liquidity

Operational

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Market

Credit

Low

We have no appetite for appearing in local press related to leaks or fines for more than 2 consecutive days.


Cascading Risk Appetite through the organisation, is a powerful way of shaping culture and aligning risk-taking The nature of the organisational unit will influence the risk dimensions used to consider appetite.

Organisational entity

Income

Capital

Organisational entity

Technology

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Reputation

Organisational entity

Income

Capital


Integrating Risk Appetite with Strategy


Identify strengths & weaknesses

Business Goals

Formulation

Internal Analysis Is our business model fit for purpose?

Identify threats & opportunities

Risk Appetite should be integrated into your organisations standard strategy framework

External Analysis

Business Drivers

Is our business model fit for purpose?

Appetite

Formulation Development of high-level strategies and allocation of scarce resources, including capital Given 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?

Business Model

Setting

From high-level strategies to specific business objectives Define specific business objectives and appetite for specific entity’s Allocation of scarce resources by entity, risk category, product lines

Appetite

Are we on-track to deliver?

Execution

Setting

Business Objectives

Strategy Management

Are we operating within appetite?

Execution Performance Management

Appetite Alignment

Risk Management

Manage strengths & weaknesses

Compliance

Manage threats & opportunities

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Initiative Management

Are 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?


Identify strengths & weaknesses

Business Goals

Formulation

Internal Analysis Is our business model fit for purpose?

Identify threats & opportunities

Risk Appetite has multiple touch points within the overall strategy process

External Analysis

Business Drivers

Is our business model fit for purpose?

Appetite

• • • • •

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

Business Model

Setting

Appetite

Are we on-track to deliver?

Execution

  

Business Objectives

Strategy Management

Are we operating within appetite? 

Performance Management

Appetite Alignment

Risk Management 

Manage strengths & weaknesses

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Compliance Initiative Management

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.

Manage threats & opportunities

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, onedimensional tools, strategy and risk maps


Identify strengths & weaknesses

Business Goals

Formulation

Internal Analysis

Identify threats & opportunities

Risk appetite should influence the your business model and help identify the ‘right’ business model

External Analysis Create value

Is our business model fit for purpose?

Business Drivers

Is our business model fit for purpose?

Business Model

Deliver value

Appetite Capture value

Business Model

Setting

The 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.

Appetite

Are we on-track to deliver?

Execution

Business Model

Business Objectives

Strategy Management

Are we operating within appetite?

Performance Management

Appetite Alignment

Risk Management

Manage strengths & weaknesses

Compliance

Manage threats & opportunities

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Initiative Management

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


Identify strengths & weaknesses

Business Goals

Formulation

Internal Analysis

Identify threats & opportunities

Business drivers play a critical role in the strategy process, and in this risk appetite framework

External Analysis Business drivers

Is our business model fit for purpose?

Business Drivers

Is our business model fit for purpose?

Objectives

Capital

Income

Appetite

Risk Appetite

Share price

Risk Exposure

Economic Value Add

Risk Dimensions

Reputational Key Risks

Return on risk adjusted capital

Risk Events

Return on risk adjusted assets

Regulatory uncertainty

Business Model

Technology innovation

Scenarios

Setting

Business Objectives

Business Drivers The critical factors that determine the success or failure of an organization's strategy and its ability to deliver shareholder value.

Appetite

Are we on-track to deliver?

Execution

Shareholder value

Performance Management Manage strengths & weaknesses

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Strategy Management

Are we operating within appetite?

Business Driver Relationships 

Appetite Alignment

Risk Management

Compliance

Manage threats & opportunities

Initiative Management

    

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.


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 Business drivers

Objectives

Shareholder value

(What are we trying to achieve?)

Capital

Income

Risk Appetite Risk Dimensions

(How much risk do we want/ need to take?)

(How do we think about risk)

Risk Exposure (How much risk we taking?)

Reputational Regulatory uncertainty

Key Risks (What are our uncertainties related to achievement of the objectives?)

Risk Events (What has gone wrong/right?)

Technology innovation

Share price Economic Value Add Return on risk adjusted capital Return on risk adjusted assets

Scenarios (What could go wrong/right?)

What determines success? Page  15

How to define success?


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. Risk Appetite and Risk Capacity

Risk Appetite

Risk Capacity

Take emergence action to reduce risk, and get back into appetite

Low

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Moderate

High

Extreme

Put the resolution plan into action to wind up the business


Using this approach enables the Board to be very clear about the operating boundaries for the business Risk Dimension

Time horizon

Low

Moderate

High

Extreme

Capacity Limit

Capital

Overnight

X% Capital @Risk

X% Capital @Risk

X% Capital @Risk

X% Capital @Risk

Above X £M

Capital

Annual

Up to X £M

X £M to Y £M

X £M to Y £M

X £M to Y £M

Above X £M

Annual

Up to X vol. Bad coverage

Up to X vol. Bad coverage

Up to X vol. Bad coverage

Up to X vol. Bad coverage

Reputation

 

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.

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The Risk Assessment process is driven by the risk dimensions used to define risk appetite enabling exposure to be aligned to appetite

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.

Reputation @Risk

Capital @Risk

Impact x Likelihood (over a time horizon) Page  18


How this approach fits together to enable Boards and Executive teams to answer some ‘big’ questions. What is our Strategy?

Business drivers

Objectives

Shareholder value

Capital

Create value

Risk Appetite Income

Business What Model

is our

Deliver business? value

Capture value

Economic Value

Risk Exposure How do we think about, and what Add Reputational Return on risk is, our Key appetite ? Risks adjusted capital Regulatory uncertainty Risk Events Technology innovation

Scenarios

What is our risk exposure?

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Share price

Risk Dimensions

Return on risk adjusted assets

Are we operating within Appetite?


Setting Risk Appetite


Risk Appetite Setting process 1. Joint Board / Executive appetite familiarisation workshop(s)

4. Board appetite setting workshop(s) 2. 1-2-1 followup meetings

3. Joint risk dimension workshop(s) 4. Executive appetite setting workshop(s)

5. Joint Appetite setting workshop (s)

6. Joint Board / Executive Appetite signoff

 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. Page  21


1. Risk Appetite familiarisation 1. Joint Board / Executive appetite familiarisation workshop(s)

2. 1-2-1 followup meetings

4. Board appetite setting workshop(s)

3. Joint risk dimension workshop(s)

4. Executive appetite setting workshop(s)

Purpose

Key deliverables

 

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

6. Joint Board / Executive Appetite signoff

One 2 hour workshop session Workshop documentation/notes/report

What does ‘good’ look like?   

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5. Joint Appetite setting workshop (s)

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?


2. 1-2-1 follow-up meetings 1. Joint Board / Executive appetite familiarisation workshop(s)

2. 1-2-1 followup meetings

4. Board appetite setting workshop(s)

3. Joint risk dimension workshop(s)

4. Executive appetite setting workshop(s)

Purpose

Key deliverables

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

5. Joint Appetite setting workshop (s)

6. Joint Board / Executive Appetite signoff

Meet with all members of the board and executive Capture and consolidate feedback/thoughts

What does ‘good’ look like? Key inputs 

Meeting guide

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All members of the board and executive can answer the question;  How does risk appetite help us make money? Create value?


3. Joint risk dimension workshop(s) 1. Joint Board / Executive appetite familiarisation workshop(s)

2. 1-2-1 followup meetings

4. Board appetite setting workshop(s)

3. Joint risk dimension workshop(s)

4. Executive appetite setting workshop(s)

Purpose

Key deliverables

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

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5. Joint Appetite setting workshop (s)

6. Joint Board / Executive Appetite signoff

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


4. Appetite setting workshop(s) 1. Joint Board / Executive appetite familiarisation workshop(s)

2. 1-2-1 followup meetings

4. Board appetite setting workshop(s)

3. Joint risk dimension workshop(s)

4. Executive appetite setting workshop(s)

Purpose

Key deliverables

Each team develop their own perspectives and thinking around appetite Create challenge and debate within, and between the two teams

5. Joint Appetite setting workshop (s)

Two 2 hour workshop (additional workshops maybe required) Documented and agreed risk appetite including selection rationale per team

Key inputs

What does ‘good’ look like?

  

Strategy document Scenario models Risk Events / Loss data

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6. Joint Board / Executive Appetite signoff

Any member of each team can confidently present their view of risk appetite and the rationale for setting their limits


5. Joint Appetite setting workshop (s) 1. Joint Board / Executive appetite familiarisation workshop(s)

2. 1-2-1 followup meetings

4. Board appetite setting workshop(s)

3. Joint risk dimension workshop(s)

4. Executive appetite setting workshop(s)

Purpose

Key deliverables

Develop a common view of risk appetite between the Board and Executive

5. Joint Appetite setting workshop (s)

6. Joint Board / Executive Appetite signoff

Clearly defined risk appetite statement with agreement on measureable limits

What does ‘good’ look like? Key inputs   

Documents from the step 4 Working models / examples based on output from step 4 Briefing/Options paper

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Any member of each team can confidently present the organisational risk appetite and its supporting rationale


6. Joint Board / Executive Appetite sign-off 1. Joint Board / Executive appetite familiarisation workshop(s)

2. 1-2-1 followup meetings

3. Joint risk dimension workshop(s)

Purpose 

4. Board appetite setting workshop(s)

Board to formally ‘sign-off’ on the risk appetite

4. Executive appetite setting workshop(s)

5. Joint Appetite setting workshop (s)

Key deliverables 

‘Sign-off’ risk appetite statement

What does ‘good’ look like? 

Key inputs 

Examples of appetite process output, as set in step 5 – dashboards, appetite alignment matrix

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‘Signed-off’ risk appetite statement

6. Appetite sign-off (Board)


Q&A

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About Manigent

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www.manigent.com | info@manigent.com | +44(0)20 7921 0022


Engaging Manigent “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

"Coupled with the implementation of a new risk management framework, significant business benefits are emerging“ – Source: Annual accounts of a

Financial Services client “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

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www.manigent.com | info@manigent.com | +44(0)20 7921 0022


Contact details Andrew Smart Managing Director Manigent Email: andrew.smart@manigent.com Blog: www.riskbasedperformance.com Web: www.manigent.com LinkedIn: http://uk.linkedin.com/in/ajsmart

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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.”

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Integrating Risk Appetite with Strategy