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4 Integrating risk management
through an enterprise architecture
4.1 Choosing a risk-based architecture
Chapter 1 brought to the reader’s attention that innovation in financial instruments
is welcome, provided management is in control of risk; Chapter 2 presented the aims
of a risk management policy, as well as its means; and Chapter 3 has shown why
exposure associated with derivatives calls for an enterprise-wide risk control system.
A key feature of a solution which is in charge of corporate exposure is that it takes
the risks of every operating unit, down to the level of each individual deal, and rolls
them up through:
Branches and affiliates,
Risk factors, and
Profit targets.
A sound solution will be able to consolidate ad hoc all exposures, new and inven-
toried, according to the way (or ways) in which the bank wants to monitor its risks.
This strategy requires critical top management decisions. One is the limits system
which puts tolerances onto dealings and provides the metrics for risk measurement
in every business line and instrument. The other relates to high technology.
The transition to next generation networks (NGN) is only just beginning. Some
telecommunications industry analysts think that telecoms operators, suppliers and
big user organizations could be redesigning, revamping and restructuring network
infrastructures for the next twenty years.
Embedding into them pre-qualification criteria for broadband, knowledge-enriched
fault recovery and other advances, and
Capitalizing on all-optical end-to-end IP systems; a policy that will change the
economics of telecoms and of networks.
For a financial institution, an integral part of the infrastructure will be an enterprise
architecture providing real-time support to all executives, professionals and other
staff. This architecture must incorporate eigenmodels (in-house artifacts specifically
designed for each application; more on this in Part 2), distributed computer power,
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Integrating risk management through an enterprise architecture 61
interactive access to in-house and public databases, and any-to-any communications
This enterprise architecture must be designed in-house. It cannot be bought off-
the-shelf. Effective risk control systems are custom-made. An integrated view to risk
exposure should integrate the bank’s strategic plan. This means a solution going well
beyond those classically available:
Covering every corner of operations, and
Providing a pattern of exposure which is both holistic and detailed, at any time
anywhere in the world.
Because this pattern of exposure must be kept dynamic, enterprise risk man-
agement means more than a simple corporate-wide summing up of risks. It inte-
grates into it portfolio management, matches assets and liabilities with risks being
assumed, and incorporate tools for prognostication of plausible extreme events. It also
includes tools for experimentation needed to review and re-evaluate strategic priorities
such as:
The choice of business activities to steer the portfolio in a given direction, and
The development of novel financial instruments able to reshape and rebalance the
company’s risk profile.
Eigenmodels must calculate the change in value of all positions, as a result of new
transactions and market movements. This concept was set out in the 1996 framework
for voluntary oversight by the Derivatives Policy Group, in the US, but the majority
of institutions have not yet implemented it, in spite of the fact that modern technology
offers the tools for doing so.
The concept advanced by this chapter is that eigenmodels should estimate profits
and losses by position in real time; an advance over the 1996 solution of Derivatives
Policy Group for brokerage firms. (The latter had asked for losses to be calculated
over twenty-four-hour and two-week holding periods with a 99 per cent confidence
level.) At the foundation of this method is the establishment of specific core risk
factors, whose notion was introduced in Chapter 2.
An architectural solution for enterprise risk management should integrate all major
classes of risk, targeting limits, evaluating current exposure, incorporating expected
risk events and, most particularly, outliers, targeting wherever and whenever they
happen and indicating where they may show up. As Figure 4.1 suggests, no major
class of exposure should be left out. To accomplish this objective, the system archi-
tecture must be flexible and adaptable to the risk control methodology adopted by
management (Chapter 6).
At the kernel of architectural design targeting a holistic approach to risk control
are simulation and ad hoc experimentation (Chapters 7 and 8). There are plenty
of reasons why the eigenmodels of this architecture must be knowledge enriched
(Chapters 9 and 10). The knowledge content of financial instruments and operations
is steadily increasing, derivatives being an example:
Software that does not match intelligence embedded in the instruments is worse
than useless, because it is narrow sighted and misleading.

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