 Building a stronger dialogue with the risk function makes for improved investment outcomes, says David Suetens, international chief risk officer at State Street.
This is the age of the risk-aware organisation. Organisations across the globe have focused on improving their approach to risk in the wake of the financial crisis...
Investment institutions — for which risk assessment is fundamental — are enthusiastic proponents of risk management. But what does risk awareness mean to asset owners and asset managers? To what extent are risk processes actually embedded in organisations and communicated across them? Do business managers and risk officers share similar views of the performance of the risk function and the value it delivers?
We recently commissioned research with the Economist Intelligence Unit (EIU) among investment institutions across the globe. The survey, “Closing the communication gap: How institutional investors are building risk-aware cultures”, canvassed opinions of 297 professionals from investment institutions. More than half of them (52 percent) were executive board members or C-level executives, and 30 percent were vice presidents, senior vice presidents or department heads.
More than three-quarters of respondents (78 percent) feel their organisation has a “very risk-aware culture” today, compared to only 30 percent that made risk their highest priority in 2007. This shift represents a significant cultural change for investment institutions. The proportion of organisations placing risk management as their highest priority has more than doubled since before the 2008 financial crisis.
Perception of risk function
Despite a greater awareness of risk, there sometimes appears to be a disconnect between business and risk functions, and differences of opinion about the risk function role at many institutions. The majority of non-risk staff (52 percent) think the risk function exists primarily to fulfil regulatory obligations, while less than a third (30 percent) of risk professionals are of this opinion. Furthermore, only 61 percent of executives/managers in non-risk functions within investment companies have confidence in the opinions of senior risk managers, suggesting that risk managers may not be fully communicating their mission to the wider organisation. Finally, only 38 percent of respondents from asset owners rate the internal information on risk as “very good”. All of these factors indicate a certain amount of frustration on both sides, possibly hindering the development of risk awareness across the enterprise. Given regulators are increasingly concerned to ensure that risk frameworks are embedded within investment institutions, it appears further progress may be required.
The study indicates that reputational risk and market risk are seen as the biggest perceived risks by both risk and non-risk functions across all investment institutions. When analysing the figures, it’s clear that while asset owners are focused on market and investment risks, asset managers give priority to reputational risk. This finding is understandable given that asset managers’ reputation depends on their performance (which is clearly connected to the market and investment risk in the underlying portfolios).
Benefits of a senior risk committee
The important role played by senior risk committees that bring together senior risk, compliance and audit representatives was also identified. The survey suggests that such committees are linked with better risk awareness, quality risk information, coordination between risk, compliance and audit, as well as fewer misunderstandings between risk and business functions. For example, 83 percent of respondents at firms with risk committees say risk is now the highest priority for their organisation, compared with just 64 percent of those without a risk committee.
Those firms with risk committees are also more likely to have their Chief Risk Officer (CRO) on the executive management board and for the CRO to play a significant role in strategy and business planning. A clear message from the survey is that institutions with a senior risk committee are convinced that the risk function contributes towards better investment outcomes (68 percent), while only 51 percent of firms without such a function are of this opinion.
CRO and Executive Board/Risk targets and rewards
Around 69 percent of institutional investors have a CRO who attends executive board meetings, meaning risk issues are represented in a key decision-making forum. Conversely nearly one quarter of CROs do not attend such meetings, and in these cases, it is likely to be more difficult for them to report risks to senior levels of the business.
Risk objectives are not always supported by incentives. For example, 88 percent of executive board members have some sort of risk target, however, less than half of them (46 percent) are financially rewarded for meeting risk targets or objectives, and 40 percent of institutions offer no financial reward for meeting risk targets or objectives.
In conclusion, institutions are making substantial headway in instilling enterprise-wide risk awareness, which should provide assurance to all stakeholders such as investors, shareholders and regulators. However, important risk information does not always reach the right people; risk professionals encounter obstacles in communicating their role and, at the same time, the business often does not fully understand the role of the risk function, often viewing it as simply a means of fulfilling regulatory requirements. Hence an ongoing shift in mindset and communication across investment institutions is still required to further raise firm-wide risk awareness.
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