Why write “The Chameleon in the Room”? How does it differ from other Risk Books?

My purpose in writing this book was to fill the gap that I perceive exists in the technical literature relating to enterprise risk management. To my mind Banks and Financial Institutions are well served by academia, since they have invested heavily in sponsoring research, but that research has focussed on producing data driven and probability orientated solutions.

Such solutions are by their nature backward looking since the only data that exists arose in the past and deduced probabilities are extrapolations based on data. Therefore those solutions only have limited reliability (a) in relation to risk drivers that occurred in the past and (b) in relation to large portfolios of risky transactions.

Some time ago this realisation led me to focus on a holistic future-oriented risk assessment and management approach, which is the foundation of this book.

The current and increasingly rapid rate of change in the global business environment has rendered data driven risk control methods inadequate. Therefore those responsible for the leadership, operation and survival of real businesses - and credit executives managing narrow B2B customer and supplier portfolios - cannot usefully employ probability based approaches.

Common business risks are well understood and can be anticipated, so owners or executives having read my book Global Credit Management – an Executive Summary, for example, will undoubtedly put in place measures to ensure the durability of their business should common risks arise.

However research and experience over the past 30 years has established that in most cases when businesses failed the cause was either:
A – An unimaginable risk driven by a unique occurrence, or
B - Due to the actions of incompetent or fraudulent management.

Incompetence and fraud are risk drivers that are well understood and managed through internal/external audits and, in the case of buyers and suppliers, by thorough analysis and careful on-going monitoring by credit risk executives.

However unimaginable risk drivers have thus far been overlooked simply because they cannot be imagined, described or counted.

Nevertheless they will occur in the future and they are the risks most likely to kill real businesses.

Examples of such risks are Black Swan Event Risk, Liquidity Risk, Operational Risk, Correlation-Concentration Risk and Ignored External Change Risk; hence my decision to focus attention in The Chameleon on these risks.

Assessment and management of common business risks is covered at a high level in the final chapter in order to round off the subject.

I am not an academic so I have written a practical work, with each challenge outlined and a practical example of a possible solution provided.

The book is available in Paperback and Kindle eBook versions worldwide through all Amazon websites, CreateSpace eStore (http://bit.ly/1IzgTEg) and eStoreT3P (http://bit.ly/1LZhALZ).

Ron Wells

Chameleon in the Room: Embrace Business Risk - Assure Survival & Growth

An innovative new risk book is now available in paperback on Amazon.com, Amazon.co.uk and other Europe based Amazon websites.

It is also available as a Kindle version on all Amazon websites worldwide; including India, Mexico, Brazil, Australia, Japan and Canada.

The paperback and pdf versions are available for sale through the eStoreT3P website; payments are processed by PayPal.

The Chameleon in the Room is unusual as it provides tools specifically designed to manage risks that are often ignored by executives; the same risks that have surprised and fatally wounded many giant enterprises, and countless SMEs.

The 108 pages are full of practical strategies and tactics for the management of the risks that injure real businesses. Real businesses are those that produce, trade, consume or distribute physical commodities, machinery, parts and equipment or consumer products and services.

Please click on this link to read the contents pages and a sample extract from the second chapter: http://www.book2look.de/book/XDU8RVItrX

Particularly addressed are the concerns and responsibilities of quoted company Executive Directors, Non-Executive Directors and ‘C-Suite’ Executives; as well as Owners and Directors of SME businesses and start-up Entrepreneurs.

Additionally Credit Executives may wish to assess their customers in the light of the 'unexpected and highly consequential' and ‘unimaginable’ risks, and associated management practices illustrated in this book.

In the face of rapid change and globalisation, data driven risk management methods alone are no longer adequate. Therefore this text presents alternative ways to cope with the diabolical array of risks that threaten non-financial businesses; including some seldom written about to date for example:
• Black Swan Events,
• Liquidity Risk,
• External Operational Risk,
• Concentration and Correlation Risk, and
• Lack of Flexibility Risk.

Related reference numbers are: ISBN: 9780957627949 / ASIN: B0118E0T84

Hedging and Liquidity Risk

A discussion (English-Chinese) in relation to the management of future price risk, was presented in Shanghai, to an invited audience of EMBA/MBA and other Business Executives. The inter-active presentation was followed by an enlightening discussion of Risk Management topics related to dealing with corporate customers and suppliers, commodity traders, banks and brokers.

One Business Executive and MBA Student commented:

‘Hedging and liquidity risk is still rather a new topic to most of businessmen and managers in China, except those working in banking and the other financial institutions. So your lecture will urge those managers, who want to grow their business in a healthier way, to learn more about the risk management tools. Simultaneously, your lecture will also raise awareness of what an important role credibility plays for a company in the market, which I think is even more important in China.’

View the presentation at:

http://www.barrettwells.com/LiquidityRiskHedgingSHAug2010encn.pdf

See a Related Article:

Hedging Future Commodity Price Risk Can Damage Your Company’s Liquidity:
Hedging future commodity price risk is something to consider, only if you guard against the chance that the outcome could damage your company’s liquidity and/or its competitive position. The English version of this article is available at: http://www.barrettwells.co.uk/liquidity.html

To obtain a copy of the Chinese version of the article click: http://www.barrettwells.co.uk/HedgingLiquidityRiskMar2010cn.pdf

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Plus ça change, plus c’est la même chose: Margining and Value at Risk – is there a better way

The concepts, ‘margining’ and ‘value at risk’ led the global financial system into a very dangerous place recently, but there is no sign that they are being challenged. Is anyone searching for or developing a better way to deal with ‘future risk’ in price volatile commodity and associated derivative markets?

When margining is in place and prices move against a company’s position its counterparties feel safe because they receive cash daily to cover their revised net exposure. That is the amount that would be due to them should the company have gone bankrupt at the close of business the previous day.

Additionally, a value at risk calculation – based on probability (gambling) theory – informs the management of the counterparties daily how much exposure they may incur during any necessary close-out period following a default, say five or 10 days, with a mathematically calculated degree of certainty. Thus empowering the management of counterparties to call for additional ‘initial margin’ or ‘adequate assurance of performance’, if it is felt that such ‘close out period related exposure’ is excessive. Let us remember at this point that value at risk calculations have proved to be nonsensical and useless in many cases, despite the claim that they provide a 95% or 99% degree of mathematical certainty.

Value at risk (VaR) calculations are based on the assumption that markets will behave in the future – as to price volatility and trend – in the same way as they did in the past. Such an assumption is patently spurious, hence the failure of VaR calculations to be of any use in a crisis situation. Nevertheless those who manage and regulate our financial markets cling to the belief that VaR calculations are capable of predicting such ‘worst case’ crisis or extreme situations.

In times of extreme price volatility or price spikes, margining drains the liquidity of companies that are on the wrong side of the price movement, particularly if they are either ‘market makers’ with open (un-hedged) positions, or physical commodity consumers that have to wait for the cash arising from the transaction hedged, thus are unable to find the cash to ‘post’ margin immediately.

If a company is thought to be having difficulty finding cash to pay (post) margin immediately it is often downgraded by the infamous S&P, Moody’s or Fitch, and immediately faces increased margin calls on existing positions hence its end in bankruptcy becomes more certain and more immediate.

At the point of bankruptcy, those counterparties that have secured their positions cheer, then pat themselves on the back and gloat as the zero sum game they play sees another august competitor brought to its knees by lack of liquidity alone.

The schadenfreude moment is short-lived however as counterparties scramble to replace the hedges lost as a result of the bankruptcy.

When Lehman Brothers was destroyed many counterparties lost millions through the need to replace hedges in the midst of the panic that followed, as good old ‘demand and supply’ drove prices to spike beyond anything forecast by any VaR calculations.

Do we have to suffer this cycle repeatedly?

The markets continue to use margining (against daily mark-to-market calculations) so it seems inevitable that the Lehman Brothers fall-out scenario will be repeated time and again, perhaps not so spectacularly nevertheless some fine companies and many jobs will be destroyed in the process. Following the Enron debacle, we saw a similar episode almost destroy Dynegy but the margining and VaR concepts were not questioned at that time.

The margining and VaR concepts and related practices need to be reviewed urgently since they appear to be unsound and unsuitable foundations upon which an untold number of interlocking financial transactions are built. The potential consequences of the failure of these concepts to protect markets have been presented in the stark reality of the ‘credit crunch’.

The danger to global financial markets persists and will persist as long as such crude and impractical tools are considered adequate. Therefore now is the time to re-examine the way in which future risk (performance and delivery) is assessed and how related exposure to counterparty bankruptcy risk is secured.

More information is available in the presentation and articles found at: http://www.barrettwells.com/CVaREnergyRiskFeb2008web.pdf,
http://www.barrettwells.co.uk/performance.html, and
http://www.barrettwells.co.uk/crmsforum.html.

Please post your ideas and comments on this subject, or write an article for a professional journal.

Ron Wells