Integrating Risk Appetite With Strategy Feb 14 2011

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  • By integrating Risk Appetite into the Strategy process, at each of the 3 steps, Boards and Executive Teams are able to answer some ‘big’ questions about their organisations.
  • Integrating Risk Appetite With Strategy Feb 14 2011

    1. 1. Integrating Risk Appetite with StrategyIntroducing a integrated risk appetite framework Prepared for Manigent webinar 14 February 2011
    2. 2. Objectives and background Objectives  Provide an outline of the Risk Appetite framework within Risk- based Performance.  Provide clarification about the role Risk Appetite has to play in the overall strategy process.  Create a discussion around risk appetite. Background  Risk Appetite is central to the Risk-based Performance approach.  Risk Appetite is a hot topic with our clients right now.Page  2
    3. 3. Risk-based Performance Management integratestraditional performance and risk management to enablesustainable strategy execution What are our Threats andWhat are we trying to Opportunities?achieve? Strategy What is our Risk Appetite? Management Appetite Are we operatingAre we on track? Performance Risk within appetite? Management Management Culture and mindset Page  3
    4. 4. The Risk-based Performance Management model isdesigned to be a continuous process: the journey is thedestinationWhat-if analysisScenario analysis Define ObjectivesWar games Clarify Strategy Define Appetite Define Risks Define Drivers Communicate what could Communicate intent hit us ‘out of the blue’ & accountabilities Model future Sustainable Operationalise uncertainty Strategy change Communicate how we will Communicate where we are provide assurance whilst doing well & doing poorly driving changeMonitor and analyseindictors, KPIs, KRIs and KCIs. Monitor & analyseCapture and analyse risk events and Define Controlslosses results Define Initiatives and actions Page  4
    5. 5. Risk Appetite, and more specifically appetitealignment, is central to the Risk-basedperformance approach Risk Appetite is central to sustainable strategy executionPage  5
    6. 6. Failures around risk appetite were highlighted ingovernmental 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.Page  6
    7. 7. What is Risk Appetite?
    8. 8. The definition of Risk Appetite is clear, but theapplication is less well understood Risk appetite is the amount and type ofrisk that is acceptable to be taken by an Risk appetite sets the boundaries withinorganisational entity over a defined time which strategy is executed – Manigentperiod, to achieve the objectives of thatentity – COSO Enterprise Risk Management 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 entityPage  8
    9. 9. Risk Appetite is a multidimensional construct, whichchanges depending on the organisational entity and whatthey are trying to achieve Annual 90 days Investment Banking example We are willing to put £x million of Overnight capital @ risk to trade on our own account over the next 12 month Extreme period. 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 Low 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 Strategic Market Credit Liquidity Operational days.Page  9
    10. 10. Cascading Risk Appetite through the organisation, is apowerful way of shaping culture and aligning risk-taking The nature of the organisational unit Organisational will influence the risk dimensions entity used to consider appetite. Income Capital Organisational Organisational entity entity Technology Reputation Income CapitalPage  10
    11. 11. Integrating Risk Appetite withStrategy
    12. 12. Risk Appetite should be integrated into your Identify strengths Identify threats & & weaknesses Business Goals opportunities organisations standard strategy Internal Analysis External Analysis frameworkFormulation Is our business Is our business model fit for Formulation model fit for Business Drivers Development of high-level strategies and allocation of scarce resources, purpose? purpose? including capital Given our business context, what is our appetite for risk? Appetite Given our appetite, have we got the right business model? Are we comfortable with the assumptions we have made? Business Model Business Setting Objectives From high-level strategies to specific business objectivesSetting 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 Strategy Are we operating to deliver? Management within appetite? ExecutionExecution Are we on-track to achieve our business objectives Performance Appetite Are we operating within appetite (are we taking too much, or not enough Risk Management Management Alignment risk?) Do we have the right level of controls in place to meet internal and external compliance drivers? Manage Compliance Manage threats Are we aligning our change agenda to our strategic agenda? strengths & & opportunities weaknesses Initiative Page  12 Management
    13. 13. Risk Appetite has multiple touch Identify strengths Business Goals Identify threats & points within the overall strategy & weaknesses opportunities process Internal Analysis External AnalysisFormulation Is our business Is our business • Engage with your shareholders model fit for Business Drivers model fit for • Determine how your organisation is going to view risk – the dimensions of purpose? purpose? appetite • Business drivers inform the choice of dimensions of appetite • Drivers and Appetite influence choice / discussions around the business model Appetite • 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  Translate the strategy into specific objectives – creating a hypothesis of our strategy Business  Cascade the strategy via business objectives through the organisation Objectives Setting 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 Appetite  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. Are we on-track Strategy Are we operating to deliver? Management within appetite?Execution  Monitoring alignment between exposure and appetite enables understanding of  Is the business operating within the boundaries set by, or cascaded Performance Appetite from the Board i.e. appetite? Risk Management Management Alignment  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 Manage Compliance Manage threats strengths & & opportunities weaknesses Initiative Page  13 Management
    14. 14. Risk appetite should influence the your business model and Identify strengths & weaknesses Business Goals Identify threats & opportunities help identify the ‘right’ business Internal Analysis External Analysis modelFormulation Create value Is our business Is our business model fit for Business Drivers model fit for purpose? purpose? Business Model Deliver value Appetite Capture value Business Model Business Business Model Objectives The rationale of how an organisation creates, delivers,Setting and captures value - economic, social, or other forms of value. Appetite Different business models have different inherit risk/reward characterises. Are we on-track Strategy Are we operating to deliver? Management within appetite? Business Models are being challenged in manyExecution industries by; Performance Appetite  Increasing and changing regulation Risk Management Management Alignment  Corporate and personal de-leveraging  Tight credit conditions Manage Compliance Manage threats  On going globalisation strengths & & opportunities  Rapidly changing technology weaknesses Initiative Page  14 Management
    15. 15. Business drivers play a critical role in the strategy Identify strengths Identify threats & & weaknesses Business Goals opportunities process, and in this risk Internal Analysis External Analysis appetite frameworkFormulation Business drivers Objectives Shareholder value Is our business Is our business Capital model fit for Business Drivers model fit for Risk Appetite Share price purpose? purpose? Income Risk Dimensions Economic Value Risk Exposure Add Appetite Reputational Return on risk Key Risks adjusted capital Regulatory uncertainty Return on risk Risk Events adjusted assets Business Model Technology innovation Scenarios Business ObjectivesSetting Business Drivers Appetite The critical factors that determine the success or failure of an organizations strategy and its ability to deliver shareholder value. Are we on-track Strategy Are we operating to deliver? Management within appetite? Business Driver RelationshipsExecution  Drivers help determine the ‘right’ Business Objectives, their KPIs Performance Appetite and targets. Risk Management  Management Alignment Select the ‘vital few’ drivers to use as risk dimensions to define risk appetite  Assess risk using the same dimensions Manage Manage threats  Link risk events back to drivers to provide powerful strategic Compliance analytics strengths & & opportunities  Use business drivers as a base for scenarios to test and validate the weaknesses objectives and risk appetite Initiative  Major changes in business drivers may lead to changes in not only Page  15 Management objectives and risk appetite, but at the most extreme, to the whole business model.
    16. 16. This Risk Appetite framework is based on a ‘vital few’ driverswhich shape thinking around risk appetite and how risk isassessed, and creates a ‘hard’ link to strategy Business drivers Objectives Shareholder value (What are we trying to achieve?) Capital Risk Appetite (How much risk do we want/ Share price need to take?) Risk Dimensions Income (How do we think about risk) Risk Exposure Economic Value (How much risk we taking?) Add Reputational Key Risks Return on risk (What are our uncertainties related to achievement of the objectives?) adjusted capital Regulatory uncertainty Risk Events Return on risk (What has gone wrong/right?) adjusted assets Technology innovation Scenarios (What could go wrong/right?) What determines How to define success? success?Page  16
    17. 17. When considering risk appetite, the Board and Executiveshould also develop a clear understanding of theorganisational 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 Put the resolution action to reduce risk, plan into action to and get back into wind up the business appetite Low Moderate High ExtremePage  17
    18. 18. Using this approach enables the Board to be veryclear about the operating boundaries for thebusiness Time Capacity Risk Dimension Low Moderate High Extreme horizon Limit X% Capital X% Capital X% Capital X% Capital Above Capital Overnight @Risk @Risk @Risk @Risk X £M Up to X £M to X £M to X £M to Above Capital Annual X £M Y £M Y £M Y £M X £M Up to X Up to X Up to X Up to X Reputation Annual vol. Bad vol. Bad vol. Bad vol. Bad coverage coverage coverage coverage 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.Page  18
    19. 19. The Risk Assessment process is driven by the riskdimensions used to define risk appetite enablingexposure to be aligned to appetite Appetite sets the boundaries for the business within which they execute strategy and create value. Reputation Capital Therefore the Appetite Alignment Matrix provides @Risk @Risk 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. Impact x Likelihood (over a time horizon)Page  19
    20. 20. 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 Share price Risk Dimensions Income Economic Value Risk ExposureBusiness Deliver How do we think about, and what Add Are we operating within What Model is our business? value Reputational is, our Key Risks appetite ? Return on risk adjusted capital Appetite? Regulatory uncertainty Return on risk Capture Risk Events adjusted assets value Technology innovation Scenarios What is our risk exposure? Page  20
    21. 21. Setting Risk Appetite
    22. 22. Risk Appetite Setting process 4. Board appetite setting1. Joint Board / workshop(s) 5. Joint 6. Joint Board /Executive 3. Joint risk 2. 1-2-1 follow- Appetite Executiveappetite dimension up meetings setting Appetite sign-familiarisation workshop(s) workshop (s) offworkshop(s) 4. Executive appetite setting workshop(s) 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  22
    23. 23. 1. Risk Appetite familiarisation 4. Board appetite setting workshop(s)1. Joint Board / 2. 1-2-1 follow- 3. Joint risk 5. Joint 6. Joint Board /Executive up meetings dimension Appetite Executiveappetite workshop(s) setting Appetite sign-familiarisation workshop (s) off 4. Executiveworkshop(s) appetite setting workshop(s)Purpose Key deliverables To ensure the board and executive have a  One 2 hour workshop session shared understanding of risk appetite.  Workshop documentation/notes/report Develop a shared understanding of the problem and proposed approach. What does ‘good’ look like?  Full and active participation by the Board andKey inputs Executive Risk Appetite training pack  Engaging debate demonstrating understanding of the business value  Answer the question – How does this help us make money? Create value?Page  23
    24. 24. 2. 1-2-1 follow-up meetings 4. Board appetite setting workshop(s)1. Joint Board / 2. 1-2-1 follow- 3. Joint risk 5. Joint 6. Joint Board /Executive up meetings dimension Appetite Executiveappetite workshop(s) setting Appetite sign-familiarisation workshop (s) off 4. Executiveworkshop(s) appetite setting workshop(s)Purpose Key deliverables To enable individual members of the board or  Meet with all members of the board and executive to ask questions, seek clarification, executive debate the topic, challenge the approach etc.  Capture and consolidate feedback/thoughts Build buy-in and support What does ‘good’ look like?Key inputs  All members of the board and executive can Meeting guide answer the question;  How does risk appetite help us make money? Create value?Page  24
    25. 25. 3. Joint risk dimension workshop(s) 4. Board appetite setting workshop(s)1. Joint Board / 2. 1-2-1 follow- 3. Joint risk 5. Joint 6. Joint Board /Executive up meetings dimension Appetite Executiveappetite workshop(s) setting Appetite sign-familiarisation workshop (s) off 4. Executiveworkshop(s) appetite setting workshop(s)Purpose Key deliverables Develop a common understanding of the  One 2 hour workshop (additional workshops business drivers maybe required). Alternative approach: Could Determine which if these drivers should be be combined with steps 1 or 4 used as risk dimensions  Documented and agreed risk dimensions, including selection rationaleKey inputs Strategy documents What does ‘good’ look like? Value driver models Board briefing/options paper  All members of the board and executive confidently discuss the business drivers and Potentially, working examples risk dimensionsPage  25
    26. 26. 4. Appetite setting workshop(s) 4. Board appetite setting workshop(s)1. Joint Board / 2. 1-2-1 follow- 3. Joint risk 5. Joint 6. Joint Board /Executive up meetings dimension Appetite Executiveappetite workshop(s) setting Appetite sign-familiarisation workshop (s) off 4. Executiveworkshop(s) appetite setting workshop(s)Purpose Key deliverables Each team develop their own perspectives  Two 2 hour workshop (additional workshops and thinking around appetite maybe required) Create challenge and debate within, and  Documented and agreed risk appetite between the two teams including selection rationale per teamKey inputs What does ‘good’ look like? Strategy document  Any member of each team can confidently Scenario models present their view of risk appetite and the Risk Events / Loss data rationale for setting their limitsPage  26
    27. 27. 5. Joint Appetite setting workshop (s) 4. Board appetite setting workshop(s)1. Joint Board / 2. 1-2-1 follow- 3. Joint risk 5. Joint 6. Joint Board /Executive up meetings dimension Appetite Executiveappetite workshop(s) setting Appetite sign-familiarisation workshop (s) off 4. Executiveworkshop(s) appetite setting workshop(s)Purpose Key deliverables Develop a common view of risk appetite  Clearly defined risk appetite statement with between the Board and Executive agreement on measureable limits What does ‘good’ look like?Key inputs  Any member of each team can confidently Documents from the step 4 present the organisational risk appetite and Working models / examples based on output its supporting rationale from step 4 Briefing/Options paperPage  27
    28. 28. 6. Joint Board / Executive Appetite sign-off 4. Board appetite setting workshop(s)1. Joint Board / 2. 1-2-1 follow- 3. Joint risk 5. Joint 6. AppetiteExecutive up meetings dimension Appetite sign-offappetite workshop(s) setting (Board)familiarisation workshop (s) 4. Executiveworkshop(s) appetite setting workshop(s)Purpose Key deliverables Board to formally ‘sign-off’ on the risk  ‘Sign-off’ risk appetite statement appetite What does ‘good’ look like?  ‘Signed-off’ risk appetite statementKey inputs Examples of appetite process output, as set in step 5 – dashboards, appetite alignment matrixPage  28
    29. 29. Q&APage  29
    30. 30. About ManigentPage  30 www.manigent.com | info@manigent.com | +44(0)20 7921 0022
    31. 31. Engaging Manigent“we have seen a reduction in our Value at Risk(VaR) of 27% in the first three months of usingRisk-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 riskmanagement framework, significant businessbenefits are emerging“ – Source: Annualaccounts 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 clientPage  31 www.manigent.com | info@manigent.com | +44(0)20 7921 0022
    32. 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.”Page  32
    33. 33. Contact detailsAndrew SmartCEOManigentEmail: andrew.smart@manigent.comBlog: www.riskbasedperformance.comWeb: www.manigent.comLinkedIn: http://uk.linkedin.com/in/ajsmartPage  33

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