Risk Management: Foundations for a Changing Financial World

CHAPTER 32

EFFECTIVE RISK MANAGEMENT IN THE INVESTMENT FIRM^af

Mark C. Brickell

Recent disasters with derivative products have intensified the focus on risk management. Although derivative products have been singled out, the risks associated with derivatives are the same as those with other instruments: It’s not what you use; it’s how you use it. This presentation highlights strategies for risk management and the specific recommendations of the Group of Thirty report.

Risk management has been in the news a great deal since the release of the Group of Thirty report on derivatives in 1993. My perspective on this topic comes both from the work done at J.P. Morgan and through my participation in the working group that prepared the report.

WHY RISK MANAGEMENT NOW?

Since early 1994, a string of events has exposed flawed risk-management policies and unexpected investment results:

• Gibson Greetings and Procter & Gamble engaged in complicated speculative investments that went sour.

• Orange County, California, declared bankruptcy as a result of losses from aggressive, highly levered bond investments. Also, the Wisconsin State Investment Board reported substantial losses from the purchase of securities linked to the Mexican peso and other currencies.

• Barings failed at the end of February 1944 because of an aggressive investment strategy and weak management controls.

• Most recently, Daiwa Bank admitted to a string of losses on bond trades that extended back 11 years.

What are the implications ...