to thewind? Caution - University of Edinburgh Business School

special featurespecial featureRiskybusinessBeing on the edge could spell dangerfor companies, particularly if they arenot prepared for potential catastropheCOMPANIES LARGE AND SMALLWILL HAVE TO REASSESS HOWTHEY BALANCE RISK ANDREWARD WHILE PLANNING FORTHE ‘UNKNOWN UNKNOWNS’US Defence Secretary Donald Rumsfeld oncenoted: ‘There are known knowns. There arethings we know that we know. There areknown unknowns. That is to say, there are things thatwe now know we don’t know. But there are alsounknown unknowns. There are things we do notknow we don’t know.’He was widely mocked for his convoluted assessmentof the military situation in post-invasion Afghanistanduring a briefing he held back in 2002. But in fact, hisanalysis is something that anyone in the business of riskmanagement should be able to relate to.And he wasn’t the first to tackle the issue of‘unknown unknowns’. The term originated with theaerospace engineering industry, with reference toproblems which could not possibly have beenanticipated.It was adopted by the military, and in an articleabout war games in 1984, Lieutenant GeneralRaymond Furlong wrote: ‘Participants in a war gamewould describe an unknown unknown as unfair,beyond the ground rules of the game. But real war doesnot follow ground rules, and I would urge that gamesbe “unfair” by introducing unknown unknowns.’The military analogy is useful in looking at thetreatment of risk in the financial services industry and, ifthe combination of circumstances which has wreakedhavoc on the global economy could be classed as in anyway ‘unfair’, then should they at least have been betteranticipated? What lessons can the industry take fromthe current situation? And what can companies do tosafeguard against the ‘unknown unknowns’?According to Carolyn Williams, Development Managerat the Institute of Risk Management, recent events shouldact as a wake-up call for the industry.‘Some businesses get so engrossed in the mathematicsof trying to model what their risks might be, particularlyin the financial services side, that they don’t look up at thewider things going on in the world,’ she said.‘It’s a matter of opening your eyes to what’s going on andapplying common sense, as well as the detailed crunchingtype of risk management which everybody has to do.‘I think there’s a whole rethink of the risk managementprocess going on. People are certainly going to try to do itbetter, and they’re going to be more in the spotlightbecause of what’s happened. So they have to be veryconfident that what they’re doing meets the bestindustry standards.’But even if the risk manager is doing the job to the bestof their abilities, is there any guarantee that their messageis getting through to the appropriate level?Paul Moore, the former Head of Group Regulatory Riskat HBOS, gave evidence to the Treasury selectcommittee’s hearing into the financial crisis in February,having said that: ‘Being an internal risk and compliancemanager… felt a bit like being a man in a rowing boattrying to slow down an oil tanker.’Moore said he told HBOS it was ‘going too fast, had acultural indisposition to change and was a serious risk toA TIMELINE OF RISK REGULATION1992:The Financial Aspects ofCorporate Governance,otherwise known as theCadbury Report, is publishedand applies to all listedcompanies reporting theiraccounts from 30 June 1993.1999:Internal Control: Guidance forDirectors on the CombinedCode, known as the TurnbullGuidance, is issued andupdated in 2005.financial stability and consumer protection’. He wasdismissed in 2005 and sued HBOS. His claim was settled,but he was subjected to a gagging order, which he onlybroke in order to give his evidence to the select committee.HBOS bosses Andy Hornby and Lord Stevenson deniedMoore’s claims at the hearing. But the allegations led toHornby’s predecessor at HBOS, Sir James Crosby, quittinghis position as deputy chairman of the Financial ServicesAuthority, though he also said Moore’s allegations had nomerit. The FSA said it had had concerns about riskmanagement at HBOS dating back to 2002.Crawford Paul (Class of 1981), Director of the insurancebroker Coverall Worldwide, said that it’s clear from suchexamples that the area of risk management needs to begiven more respect.‘There has to be a broader appreciation of what riskactually is and its status should be elevated to thecompany board room, be more broadly defined and not,as has traditionally happened, left to the insurancemanager,’ he said.‘Businesses need to revisit risk and build it more intotheir business plans. They should take a look at theirskill sets, in each of the different areas of their business.They need to have people talking across the company,rather than just up and down it and look at totalenterprise risk and the interdependencies.’ Dr DavidHillson, Director of the international risk consultancy2002:Sarbanes-Oxley Act comesinto force for US-listedcompanies, in the wake ofthe Enron and WorldComcorporate and accountingscandals.2003:The Combined Code onCorporate Governance isintroduced by the FinancialReporting Council for listedcompanies in the UK, and iscurrently under review.‘THERE’S A WHOLERETHINK OF RISKMANAGEMENTGOING ON. PEOPLEARE GOING TOHAVE TO DO ITBETTER AND AREGOING TO BEMORE IN THESPOTLIGHT NOWCarolyn Williams20 | aluminate | april 2009www.alumninet.man.ed.ac.ukwww.alumninet.man.ed.ac.uk april 2009 | aluminate | 21