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Global Risks corporate responses


Risk - early Italian risicare ( to dare'), from late Latin risigus. ... Black swans cannot be predicted, nor prevented, but can be managed ... – PowerPoint PPT presentation

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Title: Global Risks corporate responses

Global Risks corporate responses
  • Sean Cleary
  • IRM SA Conference 2007
  • Johannesburg, October 16, 2007

Origins and meaning
  • Risk - early Italian risicare (to dare), from
    late Latin risigus. Skeat relates it to Spanish
    risco a steep, abrupt rock, from whence the
    sense of danger may easily have arisen among
    sailors. Skeat cites the Spanish arriesgar to
    venture into danger, literally to go against a
  • The OED dates the words origin in English to
    1661 and defines it as hazard, danger exposure
    to mischance or peril. Hazard has its origins in
    the Arabic al zahr, meaning dice.
  • Modern concept arose about 300 years ago. By
    1719, denoted the chance or hazard of commercial
    loss, specifically in the case of insured
    property or goods.
  • In Against the Gods, Peter Bernstein calls
    mastery of risk
  • the revolutionary idea that defines the
    boundary between modern times and the past the
    notion that the future is more than a whim of the
    gods and that men and women are not passive
    before nature. Until human beings discovered a
    way across that boundary, the future was a mirror
    of the past, or the murky domain of oracles and
    soothsayers who held a monopoly over knowledge of
    anticipated events.
  • Risk is measurable uncertainty, characterised by
    a measure of randomness, with knowable and
    thus calculable probabilities. Uncertainty is
    unmeasurable randomness with unknowable

Risk is the business of business…
  • Risk is the business of business anticipate
    change and manage it on the basis of an opinion
    about the future
  • Risk intimately linked to innovation. Nobel
    prize-winning economist William Baumol
    innovation most important feature of market
    economy. Competition forces us to innovate most
    innovation comes from companies, not universities
  • Identifying, assessing, assuming, mitigating and
    managing risk is core of business behaviour.
    Innovation poses risks, but only sustainable way
    of managing business risk in a fast-changing,
    competitive marketplace
  • If company is a living system, building capacity
    to resist shocks through organic adaptation is
    key. Change now continuous, not episodic, and
    language of life sciences more suited to the risk
    management than industrial prescripts 99 per
    cent of all species are extinct 1 per cent that
    survived not strongest or smartest, but most
    adaptive to changes experienced
  • Jared Diamond Guns, Germs and Steel new work
    exploring why diverse communities choose to fail
    or survive. Four reasons for failure, all
    relevant for modern businesses
  • Failure to anticipate a problem
  • Failure to perceive it once it has arisen
  • Failure to try to resolve it once it has been
    recognised and
  • Failure in ones attempts to solve it

Risk management principles
Communicate management intentions Clarify
corporate expectations Strengthen risk awareness
Risk Control Verify results
Determination of Risk Profile
Risk Identification and Analysis
Information and Communication
Risk Assessment
Monitoring for early warning
  • Define risk management strategies
  • Identify institutional collaborators
  • Allocate tasks based on comparative advantage

Comparison of Market Risks
Competitive challenges
  • Critical factors for competitive advantage
  • Brace for turbulence
  • Manage risk skillfully
  • What does this mean?
  • Build first-rate and relevant information,
    knowledge, understanding and skills
  • Build in capacity to anticipate, absorb and
    manage rapid and discontinuous change

Top 10 Risks compared Brainstorming in IC and GS
- November 2005
  • Intelligence community
  • Persistent and challenged differences between
    high low opportunity geographical areas,
    resulting in uncontrollable migratory flows and
    humanitarian crises
  • Intelligence communitys inability to overcome
    cognitive straightjackets/adopt new approaches
  • Competition for resources (primarily oil and
  • Synergies between terror, crime and drug networks
  • Pandemics, including avian flu and HIV/AIDS
  • Ability of extremist factions to shape Islams
  • WMD in the hands of terrorist organizations/
    rogue states
  • Inability of societies to deal with cultural
  • Inability to come to grips with the roots of
    radicalization and extremism
  • Irreversible disruption of global environmental
    equilibriums (incl. global warming)
  • Goldman Sachs
  • Hedge funds and derivatives
  • World oil supply
  • Wealth disparities in emerging economies
  • Opportunities and challenges for growth in China
  • Trade liberalization
  • The dollar and the twin deficits
  • Environmental accords
  • Geopolitical conflicts
  • Global terrorism
  • World health conditions

WEF Global risks
Global Risks correlated
- Affect business but are not operational,
project or financial risks - Are highly
interdependent and often systemic (i.e. do not
manifest in isolation and can result in extensive
conflation) - Characterised by uncertainty,
sharp discontinuities, non-linearity and
disproportional impacts
Two senses of systemic risk
  • As used in financial markets
  • …the risk that an event will trigger a loss of
    economic value or confidence in, and attendant
    increases in uncertainty about, a substantial
    portion of the financial system, that is serious
    enough to quite probably have significant adverse
    effects on the real economy.   Group of 10,
    Summary Report on Consolidation in the Financial
    Sector, January 2001,
  • But more broadly
  • …Systemic risks are risks that originate in an
    identifiable event that threatens predictable
    harm to one element of the system and which, due
    to links between different systemic components is
    (or has the potential to be) amplified in either
    magnitude or direction, leading to substantial
    damage to the system as a whole. OECD, WEF 

Key Global Risk Themes at Davos 2007
  • Dangers of complacency in the face of benign
    conditions …
  • The new year will begin with the greatest
    divergence for a generation between the general
    view of global risks and risks as priced in
    financial markets, Lawrence Summers, Harvard
  • … are compounded by increasing interdependency
  • Interdependence is the defining issue of
    the 21st Century,
    Tony Blair, Prime Minister of the United Kingdom.
  • Risk conflation and interconnectedness make
    the world increasingly
    vulnerable to the cascading nature of risk
  • … and a fundamental disconnect between risk and
    mitigation …
  • … even though some tactical gains have been made
    in specific areas of risk - such as co-operation
    on dealing with terrorism, and improved
    preparedness for a major pandemic outbreak.

Key challenges
  • Inherent elements
  • Complexity
  • Inter-connectivity
  • Causality
  • Challenges in mitigation
  • Divergent perceptions
  • Policy agendas, time-frames and trade-offs
  • Institutional fragility and incapacity

Neo-classical economicshomo economicus
  • Neo-classical economic theory suggests that
  • systematically apply rational calculations to
    economic decisions to enable optimisation of the
    utility of choice in the context of constraints
  • Assumes we make decisions in a state of
    deliberative equilibrium, where preferences,
    information and constraints would shape the
    decision if time and computational ability were

The sub-prime credit crisis
  • Global glut in savings in most of Asia and Middle
  • Largely offset by excess of investment over
    savings in West, especially US. US current
    account deficit absorbed almost two-thirds of
    gross savings surplus in recent years
  • After stock market collapse in 2000, US
    government and US households became net consumers
    of capital financial surplus in business sector
    Private Equity boom
  • Excessive household spending sustained by U.S.
    monetary policy. Rising spending led to rise in
    household debt, financed by borrowing against
    homes. Debts transmitted through securitised
  • Led to sub-prime crisis several months until
    related trades unwound. Funds and banks around
    world purchased bonds, or risk related to bonds,
    backed by sub-prime home loans, bundled into
    collateralized debt obligations
  • J.P. Morgan estimates about 1.5 trillion in
    collateralized debt obligations, and about 500
    billion to 600 billion in structured finance
    collateralized debt obligations, bonds backed by
    sub-prime and other mortgages, and commercial
    mortgage-backed securities. Much of the risk thus
    amplified by collateralized debt obligations.
  • Emergence of these complex products coincided
    with growth of credit derivatives allowing banks
    and funds to hedge exposure. Further difficulties
    with bank-owned, off-balance sheet conduits and
    other specialised vehicles with investments in
    asset-backed securities Some have struggled to
    raise finance after withdrawal of pension funds
    and insurance companies that normally buy their
    short-term paper
  • U.S. Federal Reserve interest rate cut was needed
    to stabilise markets

Recovery from the crisis
  • Core uncertainty in assessing recovery
    trajectory, is extent to which central bankers
    can definitively influence the creation of money
    and credit. Trade in derivative instruments in
    2006 is estimated at U.S. 300 trillion, over six
    times global GDP of U.S. 48 trillion. Effects of
    efforts by the Fed or the ECB to prime pump by
    reducing rates, are uncertain.
  • After the crisis, buyers of derivative and
    securitised assets will not simply accept the
    agencies ratings. Less paper will be issued by
    sub-prime brokers and fewer packaged products by
    investment houses. Prices will rise and global
    credit will be reduced. Carry trades will be
    viewed more sceptically, further reducing
    volumes. Probably also seen peak of profit cycle
    of excess money in equity markets. 
  • What happens if sustained contraction in U.S.
    household spending? What other group of consumers
    will underpin growth in exports by countries with
    big current account surpluses?
  • China's rapid expansion in the past few years was
    also aided by easy global credit. Domestic
    consumption trails savings and investment.
    Tighter credit will lead to slowdown in global
    economic activity, just as low rates fuelled the
    boom. European and Japanese growth are dependent
    on U.S. and Chinese markets and cannot compensate
    for simultaneous slowing in U.S. and Chinese
  • High levels of uncertainty -- caution indicated!

Inaccurate appreciation of risk
Cognitive distortions in risk
Insights into risk from neuroscience - 1
Colin Camerer, George Loewenstein and Drazen
Prelec, Neuroeconomics Why economics needs
brains, Scandinavian Journal of Economics, vol.
106, no. 3, pp. 555579, September 2004.
Insights into risk from neuroscience - 2
Colin Camerer, George Loewenstein and Drazen
Prelec, Neuroeconomics Why economics needs
brains, Scandinavian Journal of Economics, vol.
106, no. 3, pp. 555579, September 2004.
Socio-economic trade-offs
Considerations on inter-dependency
  • Consider a utility that is part of an integrated
    system the power grid and wants to determine
    whether to invest in additional capacity or
    security measures (such as taking care of growing
    vegetation near distribution lines) to reduce the
    chance that it will cause a power outage.
  • In any highly interdependent system, such as the
    power grid, there is a systemic tendency to
    under-invest in reliability.
  • A consequence of interdependency is that a part
    of the cost of a failure is passed on to
    competitors and their customers.

Kunreuther, Howard, contribution to Global Risks
2007, Global Risk Network, World Economic Forum
Global mega-trends
  • Global systemic trends
  • Degradation of the global eco-system
  • High and growing dependence on hydro-carbons
    (exacerbating climate change and systemic
  • Increasing complexity and accelerating
    technological and social change
  • Unprecedented personal mobility and systemic
  • Exceptional levels of innovation and accelerated
    obsolescence due to global competition
  • Eastward shift of global manufacturing and
    service centres
  • Challenges to U.S. hegemony and Anglo-Saxon
    cultural dominance
  • Disaggregation of real and financial economies
  • Demographic trends
  • Aging of populations in G8, EU15 and certain
    large emerging markets, producing
  • High propensity to consume
  • Rising aversion to risk, and
  • Structural macro-economic problems due to social
    service costs
  • Rapid population growth in lower income countries
  • Migration into Europe and cultural clashes
  • Trends in social experience
  • Uneven experience of the costs and benefits of
  • Widespread perception of governments as weak at
    national and international levels

Geo-strategic data visualization
  • Geo-economic trend analysis
  • Risk trend analysis
  • Defence planning

Rising Asia EIU 2006 Shift in the economic CoG
Goldman Sachs suggests China may pass USA in real
exchange rate terms by 2027
  • Asias share of global GDP (ppp) will rise from
    35.7 percent in 2005, to 39.5 per cent in 2010
    and 43.2 per cent in 2020
  • Relatively high growth in the USA will see its
    share fall only slightly from 20.8 per cent to
    20.3 per cent and then 19 percent over the same
  • Europes share allowing for expansion of the EU
    from its present 25 members to 28 in 2010, and 33
    in 2020 is forecast at 21 per cent, 20.2 per
    cent and 19.1 percent respectively
  • Chinas share of the global economy by the same
    measures may rise from 13.7 per cent to 19.4 per
    cent over the fifteen years
  • India advances from 6.2 percent to 8.8 percent
  • Most other regions and countries cited within
    them will maintain their present shares.

Share of global GDP (p.p.p)
Global meta-challenges
  • Global economy unmediated by a polity and lacking
    an agreed normative system to underpin it
  • Inadequate attention to an management of Global
  • High systemic interconnectivity, especially in
    financial markets
  • Fracturing of the global systemic paradigm
  • Faith qua ideology challenging secular
  • Big implications for bio-technology from
    pharmaceuticals to genetic engineering
  • Failure of NPT bargain and proliferation of WMD
  • Globalization of organized crime and extensive
    links with ideological terror groups
  • Failing and failed states unresolved boundaries
    territorial disputes
  • Humanitarian disasters affecting 1.4bn people
  • Exacerbated by global climate change and
    possibility of significant increase in extreme
    weather events
  • Inability of those most vulnerable to address

How will things develop?
  • Revival of faith religion
  • Growing acceptance of cultural diversity
    constructive relativism
  • Uneven attempts to regulate regulation
  • Emergence of new syncretistic approaches -

Vectors of engagement
  • Improving insight (and foresight) - quantum
    information and entanglement multi-actor
    strategy/scenario integration
  • Enhancing the flow of information
  • Refocusing incentives
  • Improving investment
  • Implementing through institutions

The Internet as an instrument of risk mitigation
  • Robust communication network capable of surviving
    a nuclear war
  • Nodal, packet-switching-based not circuit-based
  • Characterised by redundancy, distributed
    architecture, fail-safe measures, an autonomous
    character and formal communication and
    negotiation protocols

Systemic characteristics of effective mitigation
of global risks
  • Planned redundancy
  • Fail-safe measures
  • Distributed architecture enabling operational
    continuity and disaster recovery
  • Autonomous systems imbedded intelligence and
  • Structured communication and negotiation protocols

Global Risk mitigation system resilience in the
face of uncertainty
  • Successful risk management requires both
    foresight and insight need an institutional
    focus on developing integrated, dynamic,
    interactive frameworks
  • Redundancy, fail-safe measures, distributed
    architectures, autonomous functionality, and
    structured communication and negotiation
    protocols are key

Core global opportunities
  • One billion new consumers, moving past 5000
    threshold by 2015 annual emerging market
    spending power rises to at least 9000bn, from
    4000bn at present
  • Aging populations in USA, Europe and Japan need
    to dispose of assets against retirement pension
    provision will not be sufficient to fund long
    retirement periods
  • These assets can only be purchased by populations
    of emerging economies
  • Assumptions built into all economic growth models
    for next 40 years postulate increasing aggregate
    global prosperity China, India, SE Asia
  • Rising pressures on use of hydrocarbon energy
    sources require development of alternative
    sources if growth and prosperity in oil producing
  • Scale of challenge requires strategic
  • Health and human capital development are the two
    fundamental drivers of economic success
    productivity, personal satisfaction, social
  • Increasing longevity demands and facilitates
    superior health services and life-long education
  • Increasing complexity and accelerating change
    demands new educational models, systems and
  • Deeper financial integration and sophistication
    demands more sophisticated systems and skills
  • Media will increasingly shape individual
    expectations and frame social, political and
    economic issues
  • New and converging technologies will increasingly
    define new economic opportunities and shape
    socio-political environments
  • These investments health, education, financial
    services, media and new technologies are
    recession proof in this horizon

Resilience to risk
  • Critical factors for competitive advantage
  • Brace for turbulence
  • Manage risk skillfully
  • What does this mean?
  • Build first-rate and relevant information,
    knowledge, understanding and skills global
    battle for talent
  • Build in capacity to anticipate, absorb and
    manage rapid and discontinuous change

Humility as key to resilience
  • Black swans cannot be predicted, nor prevented,
    but can be managed
  • Highly connected, nonlinear, volatile world
    small disturbances can combine to produce large
    discontinuities, resilience only possible
    response. Resilience is ability and capacity of
    the firm to withstand systemic discontinuities.
    Companies that succeed are those which brace for
    the certainty of turbulence, and skillfully
    manage risk
  • Cantor Fitzgerald, international fixed-income
    securities firm, lost most of its workforce and
    US headquarters, but resumed trading when markets
    reopened less than a week later. Two features
  • Effective preparation planned redundancy
    mirror sites ("Chance favours the prepared mind)
  • Heterarchies" (not hierarchies) - interdependent
    relationships, laterally distributed authority,
    empowerment at all levels, knowledge sharing that
    promotes decentralization.
  • How to manage risk in conditions of uncertainty?
    Essential organizational elements - making risk
    thinking part of the culture aligning risk
    identification and assessment, strategic
    management and communication, are essential, but
    give no competitive advantage
  • Four additional critical elements
  • Build and use knowledge networks Networks offer
    the most effective organizational response to
    complexity. Good networks are built on the
    "strength of weak ties" and are most effective
    early-warning system conceivable.
  • Be aware of cognitive biases Awareness of one's
    weaknesses is a good first step to overcoming
  • Puncture denial be prepared and act fast
    Mundane but most effective. Airbus 380 "people
    were in denial" said the Chief Salesman of
  • Display humility Comes more easily to
    self-confident leaders - know strengths/weaknesses
    Surround themselves with people who complement
    and challenge them, and seek insights of others
    with expert knowledge

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