New Diamond Management & Technology Consultants Report Highlights Differences Between Winners and Losers in Managing Risks
CHICAGO, Feb. 28 /PRNewswire/ -- Senior Wall Street executives were blindsided by the subprime mortgage meltdown because their systems and processes shrouded the aggregate risks they were taking on, according to Diamond Management & Technology Consultants, Inc. (NASDAQ:DTPI).
Had these executives received and acted upon aggregated firmwide risk reports, particularly reports that simulated market stresses across each asset class, there would have been a far greater awareness of the degree to which a firm's fortunes were tied to the mortgage business. Instead, major U.S. banks and securities firms are expected to take cumulative write-downs in excess of $100 billion as the credit crisis unfolds.
"The majority, but notably not all, of decision-makers at the top banks and investment houses simply lacked the depth of information required to appropriately assess the risk of their many investments," said Aamer Baig, managing partner of Diamond financial services industry practice. "The growth of complex products directly contributed to the challenges of managing risk exposure. Since information is deal-specific and usually captured on paper and manually managed, it is virtually impossible for many risk managers to maintain timely and accurate information." In a new report, "Investing in Risk: The Enduring Legacy of the Subprime Meltdown," Diamond notes that the systems and processes at many firms are geared toward older styles of investments and simpler times, focusing on the collection and management of risk information based on the risk profile of individual investment classes or asset types. Mortgage instruments and equity risks were evaluated very differently, and in a manner that effectively resulted in "silos" of risk information. But as financial markets grew exponentially more complex and interdependent, huge decision-making gaps emerged.
A complete copy of the Diamond report is available by e-mail request to: .
"Firms should have been re-evaluating how they collected, managed, and analyzed risk information in light of the explosive growth of financially-engineered debt instruments and securities such as residential mortgage-backed securities and collateralized debt obligations," said Michelle Wilkes, a Diamond financial services partner who has worked with several major Wall Street firms.
"The few winners of today's subprime meltdown have been addressing the need for more robust data collection and risk assessment processes for more than 10 years. Rather than taking a reactionary 'meet-the-regulations' approach to risk management, these organizations view risk management as a core strategic principle and source of enduring competitive advantage." Wilkes points to five specific characteristics of the firms who are best weathering the current crisis, including: -- Policies that elevated risk management responsibilities to the highest
ranks within the organization, generally on par with CFO-level
positions;
-- Comprehensive data collection and risk assessment processes that
reached beyond individual business lines and asset classes to assess
the combined or "aggregated" risk to the firm of all of its
investments:
-- Strategies that aligned aggregated risk with corporate investment
policies and objectives, changing, in a very real way, individual
investment decisions;
-- A long-term, iterative view of infrastructure improvements that
addressed not only the consistency and timeliness of risk information,
but also the breadth and comprehensiveness of this information; and
-- A corporate culture that viewed risk assessment as a core strategic
value delivering significant competitive advantages to the firm. "In our experience, the critical difference between the victors and victims of market dislocations is the consistent investment in a risk assessment infrastructure and the institutionalization of aggregated risk management across the firm," said Wilkes.
New Culture, New 'Architecture' Required Financial services firms looking to avoid a repeat of the current crisis need to shore up their firmwide risk management capability on two fronts-culture and information architecture, said Baig.
"Firms need to readjust their culture by promoting a broad understanding and accountability for risk across all levels of the organization. For example, employees should be regularly rotated between business operations and risk control, and awarded equivalent status across divisions," said Baig. "Incentives for both risk managers and front-office traders should take into account risk-adjusted return measures.
"In addition, they should establish dedicated and independent firmwide risk functions that reach across all information silos to aggregate, measure and manage risk at the broadest level. Senior level management committees should be responsible for evaluating all aspects of risk to avoid independent decision-making that may affect the entire firm," he added.
Diamond finds the firms that are successfully navigating today's crisis also are investing in technology to meet what Wilkes calls, "the staggeringly complex computational demands of complex pricing and simulation models." "The ultimate goal should be organization-wide roll-ups of risk assessment data," said Wilkes. "Leading firms can produce aggregate, firmwide risk reporting that can be decomposed to the business unit, account, and position level. End-of-day trading positions in each region are directly sourced from the front office, which means that the front office is held accountable for the accuracy of their end-of-day positions. And the technology is in place to guarantee all accounts and positions are sourced and processed in a timely manner in every region." Data ownership and accountability is just as important as the actual simulations used to evaluate risk. Validating, tagging, and enriching information at the point of entry provides the proper context and traceability for accurate and meaningful reporting. Tagging also provides clear differentiation between observed (market) data and derived data. Finally, tagging data is required to recreate derived data at historical points in time, which is a powerful tool for evaluating risk management strategies over time.
Wilkes also recommends that all front-office pricing models be independently reviewed and approved by risk management. In addition to common data definitions, the appropriate policies and processes should be in place to ensure instruments are modeled consistently, irrespective of where and by whom they are booked.
"The modeling methodology used for a given instrument should accurately reflect the value of the instrument under a variety of conditions," said Wilkes said. "Non-linear options, for example, should be fully re-priced for every condition being simulated in the risk analysis. The implications for firms that have millions of positions in their proprietary trading accounts are significant, as fully re-pricing options is computationally intensive and poses many data model and integrity challenges." Investing in the Fundamentals Baig notes that CEOs at firms that are weathering the subprime crisis are the champions of their firm's technology direction. Their chief information officers (CIOs) have peer status with the leaders of other functional groups and are expected to provide strong direction regarding risk management practices and tools, as opposed to functioning as mere order-takers. Instead of focusing on quick fixes and managing IT costs, CIOs at the leading companies are look for ways to improve their firms' risk infrastructure.
"We continue to see significant investment in projects that provide incremental improvements rather than attacking the fundamental issues associated with today's information environment," cautions Baig. "This is a mistake, as the infrastructure required to support this level of integration is complex and requires constant investment." Diamond's experience suggests that the cost of appropriately addressing today's governance, modeling consistency, data transparency, and risk control issues could require an investment between $200 million and $250 million. The outcome, however, is an organization with risk controls, transparency, and accountability that reaches all the way from a firm's trading positions to the board level.
About Diamond Diamond is a management and technology consulting firm. Recognizing that information and technology shape market dynamics, Diamond's small teams of experts work across functional and organizational boundaries to improve growth and profitability. Since the greatest value in a strategy, and its highest risk, resides in its implementation, Diamond also provides proven execution capabilities. We deliver three critical elements to every project: fact-based objectivity, spirited collaboration and sustainable results. Diamond is headquartered in Chicago, with offices in New York, Washington, D.C., Hartford, London and Mumbai. Diamond is publicly traded on the Nasdaq Global Select Market under the symbol "DTPI." To learn more, visit http://www.diamondconsultants.com/ Contacts: David Moon
Media Relations
+1.312.255.4560
Margaret Boyce
Investor Relations
+1.312.255.5784
DATASOURCE: Diamond Management & Technology Consultants, Inc.
CONTACT: David Moon, Media Relations, +1-312-255-4560, , or Margaret Boyce, Investor Relations, +1-312-255-5784, , both for Diamond Management & Technology Consultants, Inc.
Web site: http://www.diamondconsultants.com/
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