1
Q
Definition: Line Management
A
To integrate RM into business processes
2
Q
Definition: Portfolio Management
A
To aggregate risk exposures & ID diversification effects, concentrations of risks
3
Q
List: Components of a Successful Internal Framework
(6 - Corporate Lines Really Reduce Data Spending)
A
- Corporate governance
- Line management
- Risk Transfer
- Risk Analytics
- Data & Tech Resources
- Stakeholder Management
4
Q
Definition: Corporate Governance
A
The system whereby Boards of directors, or governing bodies, are responsible for the governance of their orgs upon appointment by shareholders
5
Q
List: Roles of the Board
(9 - MGS ARE CAC)
A
- Governing the company as whole
- Ensure effective RM in place
- Setting risk appetite
- Approving risk strategy and/or policies of the org
- Monitoring key risks
- Ensuring compliance with supervisory requirements
- Supporting the establishment & maintenance of a good risk culture
- Reviewing the outcomes of the RM process
- Ensuring alignment of interests of management with supervisors
6
Q
List: Roles of Line Managers (3)
A
- Day-to-day management & reporting on all risks within the org
- Implement the ERM policies
- Understand the risks that they are taking & aware of the extent of their risk-taking powers
7
Q
Definition: Internal Controls
A
Processes effected by a company’s Board, management or other staff, designed to provide reasonable assurance as to the achievement of the company’s objectives
8
Q
List: Main Aims of Internal Controls (5)
A
- Ensuring accurate & adequate record-keeping
- Preventing fraud & safeguarding the company’s assets
- Guaranteeing the accuracy of financial statements
- Responding appropriately to risk
- Ensuring compliance with law & any supervisory guidance
9
Q
List: Main Recommendations of the Cadbury Code (7)
A
- There should be a full Board meeting at regular intervals
- The Chair & CEO should be different individuals
- Most NED’s should be independent
- NED’s should have key responsibilities for certain control & monitoring functions
- Shareholders should approve directors’ service contracts more than 3 years
- Directors’ renumeration should be subject to review by a renumeration committee made of mostly NED’s
- Company reports should be balanced & understandable
10
Q
List: Key Principles for Excellence in Corporate Governance (5)
A
- Communication with stakeholders
- Independence of the Board
- Board performance
- Board renumeration
- Board appointments
11
Q
List: Roles of the RM Subcommittee of the Board (3)
A
- Strategic oversight of the company’s ERM on behalf of the Board
- Setting risk policies
- Gather relevant info on key risks & assessing their treatment by the RMF
12
Q
List: Responsibilities of the RM Subcommittee (5)
A
- Ensuring a sustainable ERM framework is established & implemented
- Assessing whether RM objectives have been achieved
- Ensuring compliance with any supervisory requirements for RM
- Reporting on risk to the Board
- Keeping abreast of developments in RM
13
Q
List: Roles of the Audit Subcommittee (3)
A
- Monitoring the integrity of financial statements
- Monitoring & reviewing internal assurance functions
- Recommending, monitoring & reviewing the external auditor
14
Q
List: Themes of the Walker Review (5)
A
- The ‘Comply or Explain’ approach is the best route to better corporate governance
- Need for more ‘challenge’ in Board discussions
- Board-level engagement of risk oversight should be materially increased
- Need for better engagement between fund managers acting on behalf of their clients as beneficial owners, & Boards of investee companies
- The remit of the Board renumeration should be extended to cover the other senior influential employees
15
Q
Definition: Risk Culture
A
A subset of overall culture, which relates specifically to the approach taken to RM
16
Q
Definition: Good Risk Culture
A
A risk culture in which people know, and do the right thing, even if there is no specific rule of policy telling them what to do, rather than acting on their own interests
17
Q
List: Good RM Culture should encourage (7)
A
- Consultative leadership
- Participation in decision-making on risks
- Openness
- Accountability rather than blame
- Organisational learning
- Knowledge sharing
- Good internal communication
18
Q
List: Tools for improving Culture in an org (9)
A
- Conducting risk training
- Giving positive feedback to those who manage risk well & display appropriate behaviours
- Raising risk awareness by publicising RM success stories
- Introducing post-project review processes focusing on RM
- Setting up a central risk database to include info on all risks
- Ensuring that part of each employee’s renumeration is dependent on the achievement of RM objectives
- Introducing a clear process for the escalation of risk issues
- Focus on how to fix problems that occur rather than blame
- ID specific members of different departments who have clear risk responsibilities & are first contacts for risk-related concerns
19
Q
List: SOX Key Features (10)
A
- Formation of PCAOB to inspect published accounts & prosecute breaches
- Increased accountability of CEOs & CFOs - must certify financial statements
- Each published report must contain an Internal Control Report
- CEO & CFO legally responsible for setting up, maintaining & evaluating internal controls
- Audit committee staffed by independent directors with at least 1 financial expert
- Banning provision of audit & non-audit services by the same firm
- Limiting external auditor appointment to 5 years
- Illegal for directors to interfere with the audit process
- Illegal for employees to alter, conceal, falsify or destroy records
- Strengthening separation of analyst & investment bankers
20
Q
List: COSO ERM Framework Principles (7)
A
- ERM should be integrated into the org’s strategy
- Risk represents opportunity as well as downside
- ERM is a multi-dimensional & iterative ongoing process
- ERM should be integrated into everyday processes
- Everyone has a role in RM, but ultimate responsibility is with the CEO
- Any RM process is imperfect
- Any implementation of RM must balance cost with benefit
21
Q
Definition: COSO Cube Dimensions (3)
A
- Activities required to demonstrate internal controls (RM processes)
- Business areas covered by the framework (e.g. Operational, Strategic)
- Levels of application (e.g. Subsidiary unit, Division, Entity)
22
Q
List: ISO 31000 Key Features (3)
A
- Emphasis on possibility of an effect rather than possibility of an event
- Focus on how effects could affect objectives
- Viewing the risk framework as being dynamic
23
Q
List: Orange Book Key Principles (6)
A
- Importance of linking risks to objectives
- Distinction between the risk & its impact
- Need to distinguish inherent & residual risks
- Prioritisation of risks is more important than quantification
- Risk appetite should be subdivided into corporate, delegated & project
- Importance of regular reviewing & reporting + dedicated risk committee
24
Q
List: Mandatory vs Advisory Frameworks
A
Mandatory: Basel II/III, Solvency II (legally required)
Advisory: COSO, ISO 31000, Orange Book (best practice guidance, not legally binding)
25
List: Reasons for different Capital Adequacy Standards (5)
1. International business having operations that are regulated by different territories
2. Having subsidiaries that operate in different sectors
3. Having subsidiaries that operate in different areas within the same sector
4. Having subsidiaries / portfolios within the same sector subject to different regulatory requirements
5. Having subsidiaries which are new ventures or acquisitions & are at different lifecycle stages
26
List: Role of Professional Bodies (3)
1. Ensure members are adequately trained
2. Ensure members maintain their competence
3. Power to discipline members who fail to maintain appropriate standards
27
List: Role of Professional Regulators (1-3)
1. Maintain public confidence in the profession by:
a. Setting standards
b. Monitoring adherence to the standards
c. Disciplining in cases of non-coherence
28
List: Role of Industry Bodies (2)
1. Promote the interest of their members through lobbying
2. Raise standards in an industry
29
List: Role of Industry Regulators / Supervisors (3)
1. Protect the consumer - Maintain public confidence by controlling the activities of the individuals & orgs
2. Licensing which individuals can hold a particular role or which orgs can operate
3. Restrict orgs which do not comply
30
Definition: Functional Regulation
Different authorities oversee different activities
31
Definition: Unified Regulation
A single regulator covers a broad range of activities
32
List: Advantages of Unified Regulation (6)
1. Easier to regulate financial conglomerates
2. Ensures a consistent approach across various financial services activities
3. Limits any incentive for regulatory arbitrage
4. Economies of scale
5. Better sharing of ideas between regulatory staff
6. Improved accountability
33
List: FCA Aims (3)
1. Protect consumers
2. Ensure industry remains stable
3. Promote healthy competition between FSP's
34
List: 3 Pillars of the Basel Accords (3)
1. Imposes a minimum regulatory requirement determined by the amount of Credit, Market & Operational risk to which the bank is exposed
2. Deals with the issue of supervisory review - Review internal systems, processes & risk limits to ensure that the bank has set aside sufficient capital for its risks
3. Deals with the level of disclosure that the bank is required to undertake to the public - Facilitate discipline on firms through appropriate pricing for capital
35
List: Main Criticisms of Basel II (9)
1. Too much emphasis placed on a single number that aggregates a wide variety of risks
2. Some risks are difficult to quantify
3. Some risks are only given cursory consideration
4. More complex calculations do not mean more reliable calculations
5. Costly to implement
6. Banks all measure risks the same way - Risk-herding
7. Market values may under-value certain assets where the risk of loss is low
8. Pro-cyclicality
9. Banks could become over confident in their risk control due to the complexity of the risk modelling
36
List: Addresses of Basel III > Basel II (5)
1. Liquidity, Systemic & Counterparty Risk
2. Strengthens the capital requirements for banks
3. Introduces a conservation buffer
4. Changes the minimum ratios of T1 & T2 capital
5. Allows some flexibility in capital requirements in times of financial crisis to limit pro-cyclicality
37
List: Aims of Solvency II
| (6 - CHERPS)
1. Economic risk-based solvency requirements
2. More comprehensive requirements taking account of both A & L risks
3. Requirements to hold capital against Market, Credit, Operational & UW risk
4. Emphasis that capital is not the only way to mitigate against failures
5. Prospective focus
6. A streamlined approach to recognise the economic reality of how groups operate
38
List: 3 Pillars of Solvency II (3)
1. Quantitative requirements designed to capture UW, Credit, Market & Operational Risk
a. Standard or Internal Models
b. SCR & MCR
2. Qualitative requirements on undertakings such as RM & supervisory activities
a. ORSA required for SCR & MCR
3. Supervisory reporting & disclosure
39
List: Purpose of ORSA (2)
1. Assessment of adequacy of RM
2. Assessment of current, & likely future solvency position
40
List: ORSA requirements (5)
1. ID risk exposures
2. ID RM process & controls in place
3. Quantify ongoing ability to continue to meet solvency capital requirements (SCR & MCR)
4. Analyse quantitative & qualitative elements of business strategy
5. ID the relationship between RM & the level + quality of financial resources needed & available
41
List: Similarities between Basel II & Solvency II (6)
1. Both describe requirements in 3 pillars
2. Pillar 1 is a risk-based approach
3. Pillar 2 is own assessment
4. Pillar 3 is disclosure requirements for risks, RM & capital adequacy
5. Both designed to be suitable for multi-national firms
6. Both are mandatory
42
List: Differences between Basel II & Solvency II
| (3 - CP1)
1. Basel II based on market dependence on contagion - Solvency II not designed for systemic risk for insurers
2. Basel II takes a more prescriptive approach than Solvency II
3. Solvency II Pillar 1 requires assessment of MCR & SCR
43
Definition: Credit Rating
Issued by a credit rating agency as an indication of credit worthiness
44
List: Risk Elements of the S&P Rating Framework (3)
1. Sovereign risk analysis
2. Business risk analysis
3. Financial risk analysis
45
List: S&P ERM Assessment Areas (5)
1. RM culture
2. Risk control
3. Extreme event management
4. Risk models & Capital Models
5. Strategic RM
46
Definition: RM Culture
The degree to which risk & RM are important considerations in all aspects of corporate decision making
47
List: S&P Control Assessments (4)
1. How well the company's risk ID procedures are carried out
2. How well risks are monitored on an ongoing basis
3. Limits set for retained risks, how these limits will be adhered to & the consequences / actions taken when limits were not met
4. The execution of the RM process
48
List: S&P Assessments of Risk & Capital Models (8)
1. Range, quality & use of indicative, predictive & sensitivity risk measures
2. Degree to which the choice of risk measures is consistent with the complexity of the risk & intended usage
3. Appropriateness of the choice of projection approach
4. Associated operational issues
5. Whether the models assess risk & capital consistently across the whole company & hence the ability to determine aggregate capital requirements
6. Modifications of any standard formula used for appropriateness to the lines of business
7. Whether a single model or separate are used & how they are co-ordinated
8. Degree to which economic capital is used actively in day-to-day management, business planning & strategic decision making
49
List: Positive Strategic RM Features of S&P (6)
1. Clear decision-making w.r.t. the retained risks within the company
2. Clear strategy for investing assets owned by the company
3. Pricing of products reflects risk/return payoff
4. Appropriate capital allocation between different business units based on the capital model
5. Appropriate dividend policy, influenced by the level of risk-adjusted return on retained capital
6. Good risk-adjusted returns should be rewarded within the company
50
List: S&P Criteria Strengths (8)
1. Emphasis on ERM
2. Focus on use of economic capital or 'risk capital' measures
3. Consideration of operational performance considering risk choices & tolerances
4. Useful breakdown into components of ERM analysis
5. Encouragement of greater transparency of ERM practices
6. Intro of a classification system - outcomes easier to communicate
7. Same criteria applied to all insurance companies, but also tailored to each one
8. High rating may help orgs attract & retain customers
51
List: S&P Criteria Limitations (7)
1. Only view of S&P
2. Part of the marketing literature - too optimistic
3. Limited description is given on actual procedures
4. No explicit mention of Agency risk
5. Subjective
6. Unclear whether this approach has had a significant impact on views of insurance & reinsurance companies
7. Reliance should not be placed solely on the opinion of rating agencies
52
Definition: Balance Sheet
The value of A/L at a particular point in time to demonstrate that the company has sufficient A's to cover its L's
53
Definition: P/L Statement
The revenue earned, and the costs & expenses incurred over a specific period to show the size & source of profits earned over the period
54
Definition: Economic Value
The PV of all future shareholder profits, determined on a realistic economic basis
55
Definition: EVA (2)
1. One year's results (profits) less the cost of servicing the capital that supports those results - Measure of the value created for shareholder by a company's management over the year
2. EVA = (Net Operating Profits After Tax) - (Net Assets x WACC)
56
List: IFRS Aims (3)
1. Improve transparency by enhancing the comparability & quality of financial info
2. Strengthen accountability by reducing the info gap between the providers of capital & the people to whom they have entrusted their money
3. Contribute to economic efficiency by helping investors ID opportunities & risks across the world
57
List: Disadvantages of International Accounting Standards (4)
1. Rules may not be appropriate to all companies in all circumstances
2. Standard-setting may not be entirely objective
3. Standards often allow more than 1 alternative treatment
4. Some standards are so general as to be meaningless, while others are too detailed
58
Definition: Insurance Contract
A contract under which one party (the issuer) accepts significant insurance risk from another party (policyholder) by agreeing to compensate the policyholder if a specified uncertain future event (insured event) adversely affects the policyholder
59
List: Risk Considerations of Strategic Decision Making (5)
1. Decide which risks to embrace & which to mitigate
2. Decide which risky products & projects are undertaken
3. Determine the degree & type of risk transfer & hedging to use
4. Allocate capital efficiently
5. Manage borrowing & gearing ratio
60
List: The RM Control Cycle (5)
1. ID - Defining & recording all risks in a consistent way
2. Assessment - Considering / quantifying risks in the context of risk appetite
3. Management - Ongoing treatment of the risks
4. Monitoring - Continuous recording, review & reporting of risks, losses & effective of treatments + external audit
5. Modification - Alter approach as business & risk environment changes
61
List: Components of Dynamic RM (3)
1. Detect risks & control weaknesses
2. Delimit risk appetite
3. Decide on RM approach
62
List: Actions to Establish Dynamic RM (5)
1. Reset aspiration for RM
2. Establish agile RM practices
3. Harness power of data & analytics
4. Develop risk talent for future
5. Fortify risk culture
63
List: Case Studies - Governance & Regulatory Failures (5)
1. Northern Rock (2007) - Tripartite oversight failure, excessive reliance on wholesale funding, led to bank run. Fix: Unified regulation
2. Lehman/AIG (2008) - Basel II pro-cyclicality & risk herding, fire sales of MBS. Fix: Basel III conservation & countercyclical buffers
3. Equitable Life - Solvency I too simplistic, failed to hold capital against market & interest rate risk in GAR options. Fix: Solvency II Pillar 1
4. Equitable Life (ORSA) - Lack of prospective focus, did not stress future scenarios. Fix: ORSA continuity analysis
5. Enron - Failure to integrate governance & ethical controls into ERM despite having sophisticated models. Fix: COSO integration principle
F106 V2
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