What Is Risk Management? Identifying and Countering Risk

What is risk management?  Risk management is the process of identifying, prioritizing, assessing, analyzing, mitigating and controlling risk.

Risk management process should involve the appointment of a risk manager.  The risk manager will be responsible and accountable for the design and development of the risk management framework.  Risk managers also oversee the implementation of the framework by the business units. The risk manager carries out the ongoing monitoring and reporting to the executive management and the Board explaining the business risks and the effectiveness and efficiency of the risk management practice.  The risk manager recommends changes to the risk appetite or risk tolerance of the company.

Risk identification

The types of risks to which the business is exposed should be identified.  The classification must be relevant to the underlying nature of the business.  The value of process to consider and identify the risks inherent in a company should not be underestimated.

The following headings should act as prompts for the company but this is not exhaustive.  Under each risk heading are possible solutions to the risk.

Credit Risk.

1. No credit facility.  Receive your cash before you hand over the assets or receive assets before you hand over your cash.

2. Only deal with counterparties and clients that are regulated or recommended.

3. Credit check counterparties with credit agencies for default.

4. Check rating of counterparties at rating agencies.

5. Cash deposits are held with high ‘A’ rated banks.

6. Loan to be payable early.

7. Loan is secured on quality collateral.

8. Draft legal agreements to ensure prompt payment and action for delay or non payment.

9. Fees are deducted from client account – set-off /netting rights

10. Daily matching and reconciliation of trades.

11. Segregation of client money

12. Open a position with initial deposit monitor automated real time marked to market position credit profit and debit losses automatically, if outside margin, make margin call for fund injection or reduce exposure, close out position if market movement continues to erode the position.

13. Analyse the current exposure, current replacement cost of the contract by asking “what would it cost to replace the deal in the market, if the counterparty were to default today?”.

14. Analyse the potential exposure likely replacement cost of the contract by  asking “what is an estimate of the maximum likely replacement cost of the contract, if the counterparty defaults in the future?”.

Market Risk

1. Set maximum amount you are prepared to invest in the market.

2. Set stop loss for maximum fall in market you can accept.

3. Set stop loss for maximum rise so as to preserve your profit.

Liquidity Risk

1. Overdraft facility

2. Equity financing – easy injection of funds from your investors

3. Cash payable on demand from debtors

4. Predictable inflow and out flow of cash

Concentration risk

1. Set concentration limit not more that 25% of total assets in one counterparty

Operational Risk

1. Risk database

2. Maintain error register

3. Disaster recovery test/BCP

4. Verification of client identity checks

5. Service level agreement checks

6. Insurance claims promptly made.

7. Staff deputies appointment – no overreliance on one person

8. Training and competence of staff

9. Fraud –preparer of statement is not authoriser.

10. IT system efficiency test

11. Information security

12. Legal risk – review agreements

13. Regulatory risk – interpreter regulations and implement

14. Electronic trading to reduce error