Risk-awareness can be hindered by tension between business and risk officers

Risk-awareness can be hindered by tension between business and risk officers: but senior risk committees can help.

Extract from Economist Intelligence Unit Press Release:

A survey of institutional investors conducted by the Economist Intelligence Unit reveals a disconnect between business and risk functions at many institutions. Whereas a majority (52%) of non-risk staff thinks the risk function exists primarily to fulfill regulatory obligations, only 30% of risk professionals think this. Moreover, less than two-thirds of all respondents (61%) think that their organisations’ business managers have a clear understanding of the role of risk managers, and just 16% strongly agree that they do. Those in the risk function are less confident that this is the case—just 56% agree (and only 12% strongly agree).

These are among the key findings of a new report published today: Closing the communication gap: How institutional investors are building risk-aware cultures. The report, commissioned by State Street, is based on a survey of 297 institutional investors. It examines the quality of information that the business receives from the risk function, how effectively the risk function communicates with other areas of the business, whether the risk function is well understood, how well managers and staff are incentivised to achieve risk objectives, and how these characteristics compare globally.

Other findings of the research include:

Reputational risk ranks alongside market risk as a key concern. Institutional investors now rank risks to their reputation alongside risk arising from market volatility as their highest priority, with 56% of respondents identifying it among the top-three risks facing their organisations. This is ahead of investment risk (46%), regulatory risk (34%) and counterparty risk (24%). This finding reflects the response of investment organisations to the financial crisis and a series of scandals since that have blighted the public perception of the financial services sector.

Few think the quality of internal risk information – especially in Asia – is very good. Only 30% of survey respondents overall rate the information they receive from internal sources about risks that relate to their job as very good, a figure that falls to just 20% in Asia. A larger proportion of employees at institutions headquartered in North America, 36%, rate the quality of the risk information they receive as very good. This presumably reflects the increased demands of regulators and investors, as lessons are learned in the wake of the financial crisis—and also the level of investment in risk-management technology designed to enhance and integrate risk reporting.

Risk committees provide the bedrock for more cohesive risk frameworks. While correlation cannot prove causation, the survey suggests that the presence of a senior risk committee or a governance body that brings together senior risk, compliance and audit people is the foundation of better risk-awareness throughout the enterprise. Some 83% of respondents at firms with risk committees say managing risk is the highest priority for their organisation, compared with just 64% of those without a risk committee. Additionally, 87% of institutions with a senior risk committee rank internal information on major risks as good or very good, compared to just 63% of those without such a committee. Two-thirds of respondents at institutions with a senior risk committee think that business managers have a clear understanding of the role of risk managers, compared to 47% in those without such a committee. Finally, 68% of those with a risk committee agree that “the risk function helps produce better investment outcomes” compared to 51% of those without such a committee.

Regular dialogue between the front office and the risk function is associated with better investment outcomes. Those institutions that think their risk function produces better investment outcomes are also those where there is more likely to be regular dialogue between the risk function and the front office about the selection of assets and other investment matters (including counterparty risk). Some 84% of those that agree that the risk function helps produce better investment outcomes say such dialogue occurs regularly (and 35% strongly agree), while this is true of only 49% of those that do not think the risk function produces better investment outcomes (7% strongly agree).

Risk objectives are not always incentivised at senior levels. While at 88% of all investment organisations provide executive board members with some sort of risk target, at less than half (46%) are they financially rewarded for meeting them. Incentives for other functions vary, but in all cases targets are more likely to be applied than incentives. Investment professionals in North America are more likely to be incentivised than elsewhere, with 76% financially rewarded for meeting risk targets or objectives compared with 61% in Europe. Additionally, those institutions that associate risk with better investment outcomes are more likely to reward any function for meeting its risk objective or target.

The findings are based on a survey conducted in the first quarter of 2013 of 297 employees of investment institutions.

52% of respondents are either executive board members or C-level executives and 30% are vice-presidents, senior vice-presidents or department heads.

29% of respondents are portfolio managers, 21% are risk professionals, 18% are from operations and general management and 13% are from sales and product development.

48% of respondents are from asset managers, 35% are from asset owners (including insurers, pension funds and sovereign wealth funds) and 18% are from intermediaries.

39% of respondents come from investment institutions headquartered in the Asia-Pacific region, 33% are from Europe, 19% are from North America and 9% are from other regions.

© 2011 The Economist Intelligence Unit Limited. All rights reserved.

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