CRO Series Issue 1: Analyzing the evolving risk landscape amidst the COVID-19 pandemic

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By Michael Sparks, CRO, Issuer Services, BNY Mellon

How does a CRO’s role adapt to analysing risk landscape in light of a pandemic?

With the onset of the pandemic, which brought market volatility and operational resiliency challenges, the CRO role shifts into crisis management.  Real-time second-line risk oversight around decision making and enhanced risk monitoring are stepped up. The role of the CRO is to provide both risk consultancy and challenge to the executive team—this is both more challenging and more important as decision making accelerates to keep pace with a fast-moving picture.

Moving past the initial flurry of activity, the pandemic represents an interesting analytical challenge for risk professionals.  I don’t think there are any material adaptations to the role of the CRO. Our job is to identify and assess risks and drivers of risk.  A pandemic, given its relative rarity, brings with it uncertainty that presents risk managers with different challenges, but it’s a variation on a theme—not something that necessarily requires a wholesale change of approach.

In your opinion, what are best practices to consider when coping with risk in an evolving climate where financial volatility is heightened?

The best practices for managing risk are the same, but those practices are more valuable when markets are volatile.  As tempting as it might be to cut lines and limits when risk is increasing (especially for those of us who are paid to be pessimistic) this might be exactly the right time to deploy risk appetite and capacity to fulfil strategic business objectives and generate income for stakeholders.

As at any other time, robust data and vigilant monitoring are critically important.  If you’ve invested time and energy constructing solid processes and systems to capture and size your risks, you have a clear strategy supported by an approved and embedded risk appetite statement, and your business activity is informed by day-to-day risk limits reflecting both appetite and capacity, then you’ll probably be in good shape.

A cautionary note—a firm may have confidence in risk systems and processes that have been road tested in production and in place for many years, but fast-moving markets and/or idiosyncratic events may place stress on systems in ways that haven’t been observed before.  Stepping up data monitoring and analytics, and generally increasing vigilance to watch for unexpected outcomes, are prudent steps to take.

How do you see the risk landscape changing as a result of the COVID-19 pandemic?

In terms of financial risks, and markets generally, the pandemic in some ways is just another driver of macro-economic outcomes, with winners and losers in the real economy and likely a protracted economic downturn.

The more interesting point of divergence is the interest rate environment and what happens to rates over the next 5-10 years in the US and Europe.  The ultra-low rate environment we find ourselves in now is the result of a confluence of factors over the course of the last 20 years, and the pandemic is the latest shock to shape this journey.  How this environment shapes the financial system in the short to medium term is radically uncertain, and unexpected and unintended consequences are bound to arise.

Non-financial risks, in common with financial risks, will likely also behave as we’d expect them to in an economic downturn.  We’d expect to see fraud attempts increase as people become more incentivised to take risks given financial hardships and less access to credit at the lower end of the market.  Operational errors are more likely to result in losses because payment errors are less likely to be clawed back, and investors who have lost principal will seek recovery through the courts—think Citi’s recent $900MM overpayment on the Revlon syndicated loan facility.  Operational risks will evolve to reflect both transitory and more permanent changes in the way we work, and first- and second-line risk managers will have to assess how new processes or working environments change risk drivers and require different risk mitigants.

What are the areas of evaluation that have been reconsidered as a result of the pandemic?

The amount of friction created by archaic paper-based processes has increased substantially in 2020.  It seems likely that remote working will continue to be a feature of our working pattern moving forward, and this friction may just create the incentive needed for market participants to bite the bullet and embark on long overdue digitization initiatives.