Accounting systems and their standards are no ends in themselves. They are means whose function is reliable presentation of financial data. This is aiding
our understanding of the many different aspects of business operations, at the level of each individual business unit and of the company as a whole.
Technology has facilitated the production of accounting information, and its pres- entation at a faster pace than at any time in the past; but in the large majority of cases the contribution of technology has been kept at a ‘discrete islands’ level.
There is no holistic enterprise view. Only tier-1 institutions have seen to it that:
● Technology provides the necessary enterprise-wide passthrough, and
● Enables accounting, auditing, internal control, and risk management to work in synergy.
Companies that pioneered the synergy to which I refer did so because they appreciate that successful implementation of enterprise-wide solutions is insep- arable from the able usage of a streamlined accounting system. The synergy between internal control, risk management, auditing, and accounting can be appreciated from different perspectives:
● Fair value accounting makes realistic measurements, and thereby aids a process of improved management supervision.
● Fair value is steadily used as raw material for internal control communi- cations, conveying business facts to senior management, and
● In a broader sense, accounting provides the tool for planning and control- ling the distribution of the fruits of enterprise, while targeting preservation of assets.
All three bullet points converge towards the fact that the contribution of enter- prise risk management to the success of the institution lies in the making of intel- ligent measurements of the financial significance of events occurring in the conduct of business. Then comes the study, analysis and interpretation of these measurements, as well as their utilization in the exercise of informed judgments.
Real-time solutions of which we spoke in Chapter 15 are not just the better way, they are the only way to solve ongoing problems and reach factual decisions. As an example, Figure 16.3 presents the building blocks of a risk management pro- cedure for foreign exchange operations established in the early 1990s at Bankers Trust. This solution integrates the different trading modules in existence into a comprehensive risk and return presentation. Among other issues, these modules, and models going with them, address:
● Market liquidity
● Market volatility
● Credit ratings for counterparty risk
● Risk embedded in inventorying multi-currency securities
● Risk associated to derivative instruments, and
● Pricing mechanisms in conjunction to exposure.
Each measurement that leads to a management decision to change a course of action in the interest of more effective risk control contributes to overall per- formance and therefore to profitability. The collective weight of all such deci- sions which can be found at the junction of risk management and fair value accounting is a prominent factor in good governance.
MULTICURRENCY TRADING BOOK
RISK MANAGEMENT
• TRADER LEVEL
• DESK LEVEL
• CROSS RATE EXPOSURE
• CORPORATE CURRENCY RISK PROFILE
…
TRADING MODULES
MULTICURRENCY PORTFOLIO
Figure 16.3 Risk and return in foreign exchange should be computed at any time, in any cur- rency, for any counterparty
To a considerable extent, the secret of achieving the best possible balance in the exploitation of business opportunity lies in the assumptions we make about risk, and in the limits which we establish. In many cases, the observance of limits is a matter of positive and negative incentives.
Commissions paid to traders and other professionals play the positive incentives role but they frequently become perverted because they push towards assuming greater levels of risk. Commissions have a role to play in motivation, but eco- nomic rewards must be related not to one but to two factors:
● Individual effort and personal initiative
● Risk control, not only at present but also in the future, throughout the instrument’s lifecycle.
Compensation irrespective of achievement is deadly because output is bound to fall to the level of the poorest workman. Professionals must have the promise and prospect of commensurate returns as an inducement to show initiative, but the preservation of assets must always be topmost in the list of goals. Fair value added accounting provides the information to meet both objectives which, at first sight, might look contradictory.
Risk management, too, must have a reward for its capacity of successfully keep- ing exposure under control. This also should happen in proportion to achieve- ment. Additionally, the meeting of aforementioned challenges requires both forward and post-mortem thinking, a dual approach which finds itself at the junction between accounting and risk management. There is a new term identi- fying the ability to look back into past management decisions and commit- ments:
● The term is traceability, and
● The initiative in this direction has been taken by leading organizations.
Knowledge management projects assist in obtaining traceability. Their tools include expert systems, agents, and corporate memory facility (CMF), into which are registered all decisions, as well as their reasons and aftermath. We have spo- ken of the importance of CMF in Chapter 9. Expert systems10and agents11must be specifically designed for risk control, because such artifacts have provided commendable results. Precisely for this reason, top-tier companies are working to steadily improve them. By contrast, companies destined to fail are doing just the opposite.