WHEN THINGS GO WRONG, HEAR THE CLOCK TICKING

W
hen I was a Chief Risk Officer, a mistake in our opera8ons led to a mis-pricing of investments our customers held. Such
experience has allowed me to define these sure-fire steps to manage the risk of fallout from a misdemeanour.

1) Now that you know, the clock is star8ng to 8ck. You now own the problem.
2) Never, never, think the situa8on will dematerialise that you can brush under the carpet
3) Recall the Rule of Gate. Everyone appreciates that humans are imperfect, and things do happen. People forget the original
mistake, but never the cover-up.
4) Come clean straightaway, share what you know and get the apology in first. Seek forgiveness.
5) Get a new team into the area in ques8on, don't assume the idiots that got you into this mess will get you out of the problem
6) Make sure you fix the problem. Properly fix the problem.

SeSng limits is the last in the four-step risk process - iden8fy, measure, monitor and control. The risk manager needs to consider
the following:-

1) Can I set a limit on a single aggregate number, or do I need to have several limits across dimensions (8me is the main one). If I
add a dimension, then the number of limits I need to administer explodes.

2). What are the trading desk's risk and revenue appe8te? Does it line up with management and the independent risk organisa8on?

3) How o[en do I want to discuss limit breaches with the trader? Can I avoid forcing the trader to find a way around the limits?

4) How easy can I explain what the limit achieves? Am I just being reac8ve, or have I dug myself in a hole?

5) Am I doing this to make me feel be^er or for the good of the firm to avoid risk concentra8on? Can I point to evidence of large PL
swings?

6) Will the trader find them reasonable or unreasonably restric8ve? Am I ac8ng in a risk elimina8on way and apply limits wack-a-
mole style?

I have men8oned several 8mes that the art of risk management is to make informed decisions. When presented with a new trade,
here are my top ques8ons to ask:-

1) Who is the client, what is the nature of the risk transi8on, what is the background for them to want to make the trade, what is
the margin and why is the client willing to pay us for the deal?

2) Can I write an ar8cle in the London Evening Standard that presents the trade in a posi8ve ethical light? Are we part of a more
comprehensive series of transac8ons that collec8vely look dodgy?

3) For the liquid risk components, how quickly can the trader put on the first order hedges? Is the trade uncommonly large for the
market to absorb, how much is too much?

4) How unstable is the transac8on to movements in the underlying market? Can the market cope with con8nuous hedging? Will
par8cipants no8ce that you are spilling blood on the street. How bad can it get? In short, are we being paid a sufficient amount for
the risk we are taking?

5) What models have the trader used to value the trade? How dependent or sensi8ve is the valua8on based on illiquid risk
parameters? Again, how much of illiquid stuff is too much?

6) Does the way the deal team has presented the transac8on pass the whiff test?

The last point is cri8cal. Do you trust these guys? No box-8cking can improve a proper Risk person's gut feeling or "Risk Nose"
about par8cular individuals. The challenge when the stench is too fruity is to be heard and not get overruled.
To modify
One of the academic discussion characteris8cs around the risk level of covid-19 is how subjec8ve the narra8ve has been. We tend
to perceive thinkers with patches on their elbows, striving for the objec8ve truth. I have highlighted the opportunism shown by
compe8ng academic ins8tu8ons to have the most hysterical narra8ve that browbeats governments into draconian measures.

We no8ce that being on the right path is not the same as being influen8al. We only have one course so far. The reality of actual
deaths fails to bolster the rhetoric. Such separa8on between our collec8ve experience and the propaganda does not stop the
influen8al cas8ga8ng those that disagree. Please, no more adverts for the track-and-trace app.

Why is objec8ve truth a vic8m? In the 1930s, Ludwik Fleck developed a system that claimed that the process of building a body of
scien8fic knowledge is a collec8ve ac8vity. Fortunately, the Mathema8cians that push our subject forward are solitary characters,
which is one reason why it has such elegance.
When people exchange ideas, they form a thought collec8ve where they bond the group by a unique mood. This form of an
intellectual kibbutz creates mantras of what the group understand and a style of thinking. As the kibbutz establishes itself in
academic circles, the collec8ve divides into the inner prac88oner and non-specialists.

The dominant prac88oner defines the rules on how the more passive members should think about the world. They create what
looks like from those outside as objec8ve reality with an agreed set of undisputed facts. The problem here is they are subjec8ve
because the more persuasive members advance their opinion with those that want to belong to the group. We have seen this
dynamic where on a gobby member of a group of friends seems always to prevail.

Academia reinforces the validity of these facts through a filtering process disguised as peer review of academic texts. One of my
heroes, Alan Sokal, submi^ed an ar8cle on physics where he inserted cultural, poli8cal and philosophical hooks that would appeal
to academic commentators on science who adhere to prevailing fashionable indulgence that ques8ons science to be objec8ve.

While the fashionable hooks indeed enabled the publishing of his ar8cle, the content was a complete fabrica8on. He made it all up,
and his peers showed a shocking lack of rigour and lazy group iden8ty thinking. Academics reacted as any self-serving group do.
They snuffed out the brief furore and buried the act and Sokal with it.

Us on the outside of these kibbutzes find it impossible to counter these facts as we do not have the same frame of reference. It is
worse than that as we are unaware that these groups have gone off on some tangent. We find some of the protesta8ons that are
coming out of the social jus8ce movement as incomprehensive because we do not know what intellectual journey individuals go on.
I use the word "intellectual" in its broadest possible sense. We are talking a completely different language, where our ideas are to
them as either meaningless or a dangerous a^ack on their doctrine.

The good news is that for the past forty years these groups remained in academia and largely ignored by the rest of us. It is a good
job they don't dominate the narra8ve in advising governments in deriving responses to situa8ons such as pandemics.