Risk after the recession

Navita Systems’ Matias Palm takes about the risk management landscape for businesses today.

How has the economic climate affected the need for a comprehensive risk management strategy?

Matias Palm. In the aftermath of the financial crisis, two conflicting forces have affected to investments in risk management. First of all, the financial crisis was a wake-up call for both the financial industry and the regulators. This naturally results in an increased appetite for risk management strategy, as well as more firm regulations from the different market regulators. On the other hand, the financial crisis has led to a decrease in capital available for investments. Hence, many of the companies that most dearly would need to improve risk management do not have enough cash to actually do it properly. As strange as it may seem, there is still a tendency for trading organisations to cross their fingers and hope for the best.

How has technology developed the risk management landscape in recent years?

MP. Improvements to both hardware and software have positively impacted risk management. Processing speed has been gradually improved thanks to hardware development. More importantly, the continuous development of standard software infrastructure has made it significantly easier to execute risk simulations in massively parallel computing environments, bringing the simulation time down to a near real-time level.

However, the biggest improvements are thanks to the never ending perfection of the mathematical risk models. Significant effort is continuously put into this, both in academia and in corporate research, but much of this still remains to be standardised into software.

What are the key considerations and challenges facing businesses that are looking to invest in a risk management system?

MP. The key considerations vary a bit depending on the type of organisation that is making the investment. Some risk management software is designed primarily for the financial industry, with value-at-risk as the most common fundamental risk metric. Other risk management software is designed with different physical commodity trading in mind, with particular focus on properly measuring the risk in non-liquid assets, and typically with cash-flow-at-risk/profit-at-risk/earnings-at-risk as the main risk metric.

The risk management challenge is to be able to produce a good enough representation of the risk within a reasonable time frame. Risk management is all about modeling the reality, and the challenge is to create a model, which is close enough to the reality for all assets in the portfolio. This means simulation, which means time lag to get the results. This also means that the scenario models have to be consistent with the particular market; the risk model for an asset-centric energy company is fundamentally very different from that of a financial trading house.

What developments do you envisage for the future of enterprise risk management?  

MP. Full enterprise risk management is the Holy Grail of risk management. The prospect of fully quantifying all aspects of risk for an enterprise, and to have one single source for decision support about appropriate risk mitigation, is a vision that every Chief Risk Officer has. Historically, the reality has been very far from this, with several silo risk systems and large parts of the risk not covered at all. Partially this is due to the complexity in properly modelling the reality, but it is also due to lack of cross-asset knowledge among risk system designers. In practice, most risk solutions are either good at traditional financial industry, or good at properly modelling one or a few commodities markets.

I envisage that the future will bring significantly more consolidation between risk solutions from different asset classes, for example covering both the traditional financial industry and physical commodities based on best practice in both areas. I also envisage that risk solutions to a larger degree will cover multiple risk buckets and properly aggregate market risk and credit risk. Other risk buckets, such as operational risk and regulatory risk, will most likely remain on the scorecard level for the foreseeable future, since it is virtually impossible to fully quantify these risks. 

About

Mattias Palm is EVP, Head of Market & Sales, and part of Navita's Executive Management Team. He joined Navita in 2002, and has since been based in Navita's Stockholm office.

Prior to joining Navita, Palm served as senior consultant in various top-tier consultancies. In this role, he primarily worked as business consultant and solution architect of commodity trading solutions for organisations across Europe, Asia and North America. He holds an MSc. in Electrical Engineering and Computer Science from the Royal Institute of Technology in Stockholm.