Governance Culture & Incentives- Fundamentals of Operational Risk
 

Governance Culture & Incentives- Fundamentals of Operational Risk

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Governance, Culture & Incentives. -Fundamentals of Operational Risk. This presentation provides some practical tools to answer three key questions and create alignment.

Governance, Culture & Incentives. -Fundamentals of Operational Risk. This presentation provides some practical tools to answer three key questions and create alignment.

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    Governance Culture & Incentives- Fundamentals of Operational Risk Governance Culture & Incentives- Fundamentals of Operational Risk Presentation Transcript

    • Governance, Culture and Incentives Providing some practical tools to answer three key questions and create alignment Fundamentals of Operational Risk February 2013
    • Introductions & expectations Page  2 | © Manigent 2013
    • Introduction 15 years plus in Strategy & Risk Management CEO & co-founder of Manigent (consultancy) CEO & co-founder of StratexSystems (software) 2006/07: 12 month / 21 organisation research project into the integration of performance & risk management in the Financial Services industry  Created the Risk-Based Performance Management methodology     "The true output of effective risk management is a successful organisation that delivers on its strategic objectives and satisfies the needs of key stakeholders - consistently, year on year.” Manigent client Page  3 | © Manigent 2013
    • Agenda Where I am coming from What do we mean? Why is it important? Role of Strategy & Risk Appetite  Cascading Strategy & Risk Appetite  Incentives     Governance Culture Page  4 | © Manigent 2013 Incentives
    • Where I am coming from
    • Risk-Based Performance Management is designed to enable sustainable strategy execution, with risk appetite central What are we trying to achieve? What is our Risk Appetite? Strategy Management Appetite Are we on track? Performance Management Risk Management Governance & Communications Culture Page  6 | © Manigent 2013 Are we operating within appetite?
    • The Risk-Based Performance Management methodology is based on seven management disciplines Business drivers Shareholder value Strategy Manage Performance Appetite Manage Risk Align Risk-taking to Strategy Governance Appetite Culture Page  7 | © Manigent 2013 Communication
    • The Risk-Based Performance Management approach is enabled via a process that goes from formulation to execution Execution Formulation Define Strengths & Weaknesses Define Strategic Goals Define Business Drivers Define Strategic Risks Define Risk Appetite Define Strategic Objectives Define the Strategy Define the Business Model Define Strategic Controls Align Risk Appetite & Strategy Define Indicators Define Processes Define Initiatives Define Operational Risks Define Operational Controls Executive Board Page  8 | © Manigent 2013 Assess Risks & Controls Monitor Appetite Alignment
    • Definitions
    • Governance What is Corporate Governance? Culture Incentives  Corporate governance is the system by which companies are directed and controlled - Cadbury Report / UK Corporate Governance Code, 1992  The board is responsible for determining the nature and extent of the significant risks it is willing to take in achieving its strategic objectives - UK Corporate Governance Code, 2012 Corporate governance is therefore about what the board of a company does and how it sets the values of the company, and is to be distinguished from the day to day operational management of the company by full-time executives. The Code, 2012 Governance is the process and practices which define the strategic, operating and decisionmaking boundaries of an organisation (or organisational unit), and how decisions are made and implemented. Andrew Smart Page  10 | © Manigent 2013
    • Governance Other types of Governance Culture Incentives  Project Governance – the management framework within which project decisions are made.  IT Governance - the leadership and organisational structures and processes that ensure that the organisation’s IT sustains and extends the organisation’s strategies and objectives. – The IT Institute  Data Governance - is the exercise of decision-making and authority for data-related matters. Or for a longer definition, Data Governance is a system of decision rights and accountabilities for information-related processes, executed according to agreed-upon models which describe who can take what actions with what information, and when, under what circumstances, using what methods. – The Data Governance Institute Page  11 | © Manigent 2013
    • Enabling the right culture 1st Line of Defence Operational functions Culture Incentives Accountable for the risk management process Identifies, manage, mitigates and reports on operational risks Risk Management & Compliance Risk Management; design, interpret and develop overall risk management framework. Train, enable and monitor use of the risk management. Overview of key risks Compliance: Monitor and report on regulatory issues. 3rd Line of Defence Internal Audit Independent testing and verification of efficacy of corporate standard and business line compliance Provides assurance that the risk management process is functioning as designed Oversight Board & Executive 2nd Line of Defence Establishes corporate strategy and risk appetite Approves frameworks, methodologies, policies and roles & responsibilities Page  12 | © Manigent 2013 Risk Management framework Monitor Strategy & Risk Alignment The 3 Lines of defence model is a popular governance model within Financial Services and other industries Governance
    • The RACI model is also a powerful tool for cascading and embedding governance and shaping culture “The doers” Those people working on delivering the objective, managing the risk or applying the control. Governance Culture Incentives “The buck stops here” P “Keep in the picture” Those with Yes/No authority related to the objective, risk or control. “Keep in the loop” Position(s) that need to know about decision or action related to the objective, risk or control. Those involved prior to decisions or action related to the objective, risk or control. Page  13 | © Manigent 2013
    • Governance What is Culture? Culture Incentives The thing I have learned at IBM is that culture is everything – Louis V. Gerstner, Jr. former CEO IBM Culture comprises an organisation’s widely shared values, symbols, behaviours and assumptions – Rob Goffee & Gareth Jones The way we get things done around here Culture Eats Strategy For Breakfast - Peter Drucker Page  14 | © Manigent 2013
    • The seven key characteristics of a Strategy-Focused, Risk-Aware Culture Governance Culture 1. Driven by a compelling vision 2. Live by a clear set of values 3. Led with integrity 4. Align risk-taking to strategy 5. Established clear accountabilities 6. Engage in high quality conversations 7. Incentives are aligned to appetite Page  15 | © Manigent 2013 Incentives
    • Governance The right culture should ensure… Culture Incentives The right people… Are doing the right things… “The way we get things done around here” At the right time… With the right amount of challenge… To seize opportunities and manage threats… While operating within appetite Page  16 | © Manigent 2013
    • Governance What do we mean Incentives? Culture x% Base Salary x% Cash Bonus x% Deferred Bonus Page  17 | © Manigent 2013 Incentives
    • Why is this so important, today
    • The credit crunch and subsequent fall-out has brought a focus to governance and incentives Page  19 | © Manigent 2013
    • The issue of incentives and particularly bankers bonus is a live one today but we argue the issue is really down to Governance and Culture Page  20 | © Manigent 2013
    • This is not a new issue… the principal-agent problem (Agency Dilemma)  “the difficulties that arise under when a principal hires an agent, such as the problem that the two may not have the same interests”  Emerged as an issue in the 19th century as the world moved away from craft-based industries to industrialised manufacturing, leading to an increasing separation of ownership and control. Page  21 | © Manigent 2013
    • A mis-alignment in time horizons between the Chairman and the CEO is an increasing problem  “The chairman of my company has effectively been given a decade,” says the CEO of a steelmaker in Asia, “and I have three years—tops—to make my mark. If I come up with a strategy that looks beyond the current cycle, I can never deliver the results expected from me.Yet I am supposed to work with him to create long-term shareholder value. Source: McKinsey Quarterly: Tapping the strategic potential of boards Page  22 | © Manigent 2013
    • Solving the Agency Dilemma Shareholder/ Owners Board Agency Dilemma must be solved at these two points; but it starts with strong governance and a focus on developing the right culture CEO & Executive Staff Staff Page  23 | © Manigent 2013
    • Governance is still an issue for many organisations “the Board is responsible for determining the nature and extent of the significant risks it is willing to take in achieving its strategic goals.” UK Corporate Governance Code, 2010 21% “only 21% align their risks with their business strategy” Where the Board need to spend more time… – Grant Thornton Corporate Governance Review 2011 70% “results indicate a need to better educate Boards on industry dynamics and how their companies create value...” 21% “Only 21% of directors surveyed claim a complete understanding of their companies’ current strategy” – Mckinsey Global Survey – Corporate Governance, 2011 Strategy 42% Execution 47% Performance Management 67% Risk Management Approx. 1500 participants Page  24 | © Manigent 2013
    • Governance is still an issue for many organisations “44%of directors said their boards simply reviewed and approved management’s proposed strategies” “only 10% of the directors we surveyed felt that they fully understood the industry dynamics in which their companies operated” Source: McKinsey Quarterly: Tapping the strategic potential of boards Page  25 | © Manigent 2013
    • Getting the culture right is also critical We place considerable emphasis on the CEO setting the right culture, risk appetite and control framework…. Hector Sants, FSA Page  26 | © Manigent 2013
    • How can we address these Governance and Culture challenges?
    • We would argue that Tone from the top is best via an integrated approach to strategy and risk management, particularly risk appetite Vision Mission Values Shareholder value Strategy Risks Controls Shared values Processes Key Controls Incentives Behaviours Tone from the Top Risk Appetite indicators Leadership Page  28 | © Manigent 2013 What we do on a day-to-day basis Symbols What we think on a day-to-day basis
    • We believe this process enables boards (and the executive) to address governance issues identified “only 10% of the directors we surveyed felt that they fully understood the industry dynamics in which their companies operated” Formulation Define Strengths & Weaknesses Define Strategic Goals Define Business Drivers Define Risk Appetite Define Strategic Objectives Define the Strategy Define the Business Model Align Risk Appetite & Strategy Board Page  29 | © Manigent 2013
    • We believe there are three key questions that the board and executive must be able to answer, and be aligned on 1 2 3 What are we trying to achieve? How much risk are we willing to take? What are our key risks? Strategy Map Appetite Alignment Matrix Risk Map Page  30 | © Manigent 2013
    • The Strategy Map is a leading tool to enhance the communication, execution and monitoring of strategy 1 What are we trying to achieve? Strategy Map  Distil the Strategy into a clear, welldefined set of Objectives  Use a Strategy Map to map the cause ‘n’ effect relationships between Objectives  Strategy Map enables easy communications and monitoring of strategy  Use the Strategy Map to ‘bubble up’ performance, risk and controls information Page  31 | © Manigent 2013
    • The Strategy Map is a leading tool to enhance the communication, execution and monitoring of strategy Page  32 | © Manigent 2013
    • The Strategy Map is a leading tool to enhance the communication, execution and monitoring of strategy Improve Shareholder Value To succeed financially, how should we appear to our shareholders? Improve Cost Structure   Increase Asset Utilisation  Asset Turnover Enhance Customer Value  Customer Profitability  Customer Acquisition Revenue Growth Strategy  Customer Retention Create Value from New Products & Services New Revenue Sources Customer Satisfaction Product Leader To achieve our vision, how should we appear to our customers? Customer Solutions Customer Value Proposition Product/Service Attributes Price To achieve our vision, how will we sustain our ability to change and improve?  Cost per Unit •Market and Account Share To satisfy our shareholders and customers, what business processes must we excel at? Shareholder Value ROCE Productivity Strategy Quality Time Operations Theme Low Total Cost Relationship Function Service Customer Management Theme Image Relations Brand Innovation Theme Regulatory and Society Theme Human, Information, and Organisational Capital Strategic Competencies Strategic Technologies Page  33 | © Manigent 2013 Climate for Action
    • Internal Process Learning & Growth The Strategy Map articulates how an organisation creates value Objective Statement of what strategy must achieve and what’s critical to its success KPIs How success in achieving the strategy will be measured and tracked Targets The level of performance or rate of improvement needed Initiatives Key action programs required to achieve Priorities Sustainable Growth Objective KPIs Targets Initiatives Increase Investment Returns by 25% Increase Investment Returns by 25% YTD % Increase in investment returns 25%  Implement new portfolio mgt system Customer Financial Increase Shareholder value Increase Retention of competent staff by 10% Page  34 | © Manigent 2013
    • Internal Process Learning & Growth However, to create value, risk-taking must be aligned to strategy… Objective Statement of what strategy must achieve and what’s critical to its success Appetite How much risk are we willing to run to achieve the objective? Exposure How much risk are we currently running? Alignment Is our current risk-taking aligned to appetite? Sustainable Growth Objective Appetite Exposure Alignment Increase Investment Returns by 25% Increase Investment Returns by 25% Moderate High Over-exposed Customer Financial Increase Shareholder value Increase Retention of competent staff by 10% Page  35 | © Manigent 2013
    • Internal Process Learning & Growth Effective risk management also supports value creation and protection... Objective Statement of what strategy must achieve and what’s critical to its success Customer Financial Increase Shareholder value Sustainable Growth Increase Investment Returns by 25% The threats and opportunities (risks) exist which may impact achievement of objectives Objective Risks Increase Investment Returns by 25%  Unexpected changes in interest rates  Unexpected Equity movements Risks Increase Retention of competent staff by 10% Page  36 | © Manigent 2013 Thresholds The appetite and tolerance thresholds used to monitor risk Mitigation The activities undertaken to manage risk Thresholds Mitigation  Appetite  Tolerances  Controls  Initiatives  Policy & procedures  Processes
    • Financial Learning & Growth Internal Process Customer Increase Shareholder value Many different types of risks make up the organisational risk universe Strategic Risk Sustainable Growth Increase Investment Returns by 25% Finance Risk Increase Investment Returns by 25% Operational Risk Insurance Risk Hazard Risk Increase Retention of competent staff by 10% Page  37 | © Manigent 2013
    • Internal Process Learning & Growth Many different types of risks make up the organisational risk universe Unexpected changes in interest rates Customer Financial Increase Shareholder value Strategic Risk Sustainable Growth Increase Investment Returns by 25% Unexpected Equity movements Finance Risk Increase Investment Returns by 25% Operational Risk Insurance Risk Hazard Risk Increase Retention of competent staff by 10% Page  38 | © Manigent 2013
    • Once Strategy is clearly defined, the Board and Executive should develop a clear understanding of organisational risk appetite 2 How much risk are we willing to take? Appetite Alignment Matrix  Risk Appetite is set by the board and defines the boundaries within which the Executive execute strategy  Use the key business drivers to define the risk appetite statement  Use the Appetite Alignment Matrix to continuously monitor alignment between strategy and risks Page  39 | © Manigent 2013
    • Using drivers to frame appetite setting enables the Board to set clear operating boundaries Business Drivers Low Moderate High Extreme Income X% Capital @Risk X% Capital @Risk X% Capital @Risk X% Capital @Risk Capital Up to X £M X £M to Y £M X £M to Y £M X £M to Y £M Capacity Limit Reputation Up to X vol. Up to X vol. Up to X vol. Up to X vol. Bad Bad Bad Bad coverage coverage coverage coverage Page  40 | © Manigent 2013 Above X £M
    • Using drivers to frame appetite setting enables the Board to set clear operating boundaries Business Drivers Low Moderate High Extreme Income X% Capital @Risk X% Capital @Risk X% Capital @Risk X% Capital @Risk Capital Up to X £M X £M to Y £M X £M to Y £M X £M to Y £M Capacity Limit Reputation Up to X vol. Up to X vol. Up to X vol. Up to X vol. Bad Bad Bad Bad coverage coverage coverage coverage Page  41 | © Manigent 2013 Above X £M
    • Appetite Alignment Matrix is a key tool for monitoring the alignment of Risk-taking to Strategy  Enabling monitoring of the alignment of risktaking to strategy  Enables the monitoring of risks that are outside of appetite Are we operating with in Appetite?  Also shows where we are taking to much and not enough risk  Changes the risk conversation Page  42 | © Manigent 2013
    • Critical to the successful and sustainable execution of strategy is the identification and management of key risks. 3 What are our key risks? Strategy Map  An event which may occur that will impact on the achievement of objectives, either positively (opportunities) or negatively (threats).  What are the key threats and opportunities in our industry?  Go beyond the ‘usual suspects’ by using strategy as your starting point Page  43 | © Manigent 2013
    • The Risk Map provides a snapshot of the current level of Risk Exposure (‘Heat’)  The 4 perspectives are aligned to the Strategy Map  Often the risks are defined as ‘impacts’ not ‘events’ i.e the impact maybe on the customer the be event was operational Page  44 | © Manigent 2013
    • The results from the risk assessment process is presented using the same ‘risk buckets’ as risk 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  45 | © Manigent 2013
    • These powerful tools, and the underlying methodology provide the Board with the capability to meet their governance obligations and shape culture Risk Appetite Strategy Map What are we trying to achieve? Risk Map How much risk are we willing to take? Appetite Alignment Matrix So What? Page  46 | © Manigent 2013 How much risk are we running?
    • We believe that the Appetite Alignment Matrix can be used as one of the tools underpinning incentive schemes?  Use a ‘basket of indicators’  KPIs to drive the desired performance.  Indicators to reinforce ‘Operating within Appetite’ Are we operating with in Appetite? Page  47 | © Manigent 2013  KRIs (which express Risk Tolerance) to influence risktaking
    • Appetite Tolerance Incentives Risk appetite (and Strategy) is cascaded through the business via Risk Tolerance indicators and potentially to incentives schemes Risk Appetite enables the board to set the Risktaking boundaries within which the executive execute strategy. Board This should be cascaded via Risk Tolerance thresholds and reflected in incentive schemes. Corporate Therefore creating a ‘Line-of-Sight’ from Appetite to Incentives. Business Units Teams/ Individuals Page  48 | © Manigent 2013
    • Appetite Tolerance Incentives An integrated ‘suite’ of strategic and operational management information should be generated to increase transparency around risk-taking and incentive schemes Board Corporate Business Units Teams/ Individuals Page  49 | © Manigent 2013
    • When thinking about Governance and Incentives, we need to consider culture and how to create alignment using an integrated approach Governance Culture Page  50 | © Manigent 2013 Incentives
    • Questions / Comments Page  51 | © Manigent 2013
    • Contact details Andrew Smart Chief Executive Officer Manigent Email: andrew.smart@manigent.com Blog: www.riskbasedperformance.com Web: www.manigent.com LinkedIn: http://uk.linkedin.com/in/ajsmart Page  52 | © Manigent 2013