Risk Japan 2010: Stressing the risks

Speakers and delegates attending Risk Japan 2010 in June addressed some of the problems and challenges associated with forthcoming regulation as well as debating the latest advances in risk management practices, with significant emphasis placed on stress testing. By Asia Risk staff

Asia Risk’s annual risk management convention in Tokyo, Risk Japan 2010, was held at the Shangri-La hotel on June 22, moving from its previous location at the Mandarin Oriental hotel in 2008 and 2009. But the event once more addressed the issues and concerns linked with international regulation, the intricacies of regulatory change in Japan, as well as more general developments in financial risk management.

The keynote address was given by Kozo Ishimura, director of the Basel II implementation office at the Japan Financial Services Agency (FSA). Ishimura gave an update and review of the Basel II capital Accord framework as well as talking about the future of financial regulation and risk management practices. He updated Japanese risk managers on the FSA’s views on a range of important risk management subjects, including trading book treatment, the use of hybrid securities, credit value adjustments, grandfathering and procyclicality. Ishimura also mentioned the unique nature of Japanese banks, stating that operational risk is “exceptionally low” in Japan, for example, and highlighted the importance of stress tests, which became a theme for much of the day.

Tsuyoshi Oyama, a senior manager in the financial industries group at Deloitte Touche Tohmatsu in Tokyo, used his address to discuss the importance of developing stress testing away from being an ‘art’ that people appreciated into more of a ‘science’ that people could use effectively. Oyama said Japanese institutions still have a “long way to go” to get top managers involved in stress tests. To achieve top management buy-in, stress tests need to be believable and easily understood. He also stressed that scenarios should not just be based on the past and touched on the sovereign debt issues plaguing eurozone peripheral nations such as Greece, Spain and Portugal at the time.

Oyama – who also chaired a panel discussion on stress-testing practices in Japan that comprised Hiroaki Takahashi, senior economist in the treasury division at Shinkin Bank; Toshinori Kurihara, director for the planning and research office in the inspection departments at the Japan FSA; and Yasuhiko Tara, senior manager in the corporate risk management departments at the Sumitomo Trust and Banking Co – questioned the possible impact of problems spreading to major economies such as France and Italy. He also described the possibility of a ‘Chinese bubble’ which could end, and the possible impacts that could have for Japanese financial institutions.

His colleague Philip Goeth, managing director for Asia Pacific at Deloitte Touche Tohmatsu, who is based in Beijing, discussed stress testing in relation to Chinese banks, whose advances in financial risk management he generally praised. Goeth also discussed the design of stress tests, how they should be performed, the importance of internal communication of results, the design of managerial actions in response to stress tests, the development of risk mitigation and contingency plans, and the role of risk disclosure and validation. He also summed up some of the obvious lessons from the global financial crisis that emerged in 2007 and gained momentum after September 2008. Goeth attributed the root cause as the lack of economic growth in the west. Cheap money, lax lending standards, over-engineering, unsustainable leverage, lack of proper risk governance and compensation practices, interconnectedness and procyclicality all contributed to the crisis, he said. 

Speakers at Risk Japan 2010 also pointed to the over-reliance of rating agencies, under-estimation of tail risk, lack of standard on liquidity risks, flawed calibration of risk factors, governance weaknesses and procyclicality as specific failings in risk management that facilitated the crisis.

Andrew White, general manager of risk operations at the Australian Securities Exchange (ASX), gave an overview of how the central counterparty clearing (CCP) part of ASX uses stress tests to help it manage its risk positions. These stress tests are aimed at ensuring the operator of a CCP will be able to meet its obligations even in the event the participant with the largest obligations is unable to meet them.

White also stressed the importance of understanding the audience when presenting the results of stress tests. “Are they being made to the board, senior management or clients?” he questioned, citing the importance of the development of communication skills as well as the technical skill of risk managers. White added that stress tests should also establish how normal sources of liquidity will behave under stressed scenarios at a company, market or combined level. He added that liquidity stress testing should be linked to enterprise-wide risk management; scenarios should be dynamic, not static; and these scenarios should be reviewed regularly.

There was also extensive coverage of life and pension risk management issues, notably a panel discussion comprising Noboru Terada, former executive investment officer at Japan’s $1.35 trillion Government Pension Investment Fund (GPIF), and Sadayuki Horie, a senior researcher at the Nomura Research Institute and chairman of the research committee for the Alternative Investment Management Association in Japan. This session was moderated by Keiichi Kato, an actuary at Deloitte Touche Tohmatsu. Terada stated that Japanese public investment practices still lag those of other developed economies and criticised Japan’s “arcane” accounting rules. He added that even the basic fundamentals of the GPIF are wrong since it is governed by non-expert bureaucrats, not market practitioners. Terada also called for a change in the statutes that define the activities, policies and responsibilities of the GPIF, saying there should be a fiduciary duty of aligning management interests with those of beneficiaries.

Terada also called for more alpha-centric investments by pension funds, a subject that was picked up during the final session of the day, which was a panel debate about the role of hedge funds in a balanced portfolio.

The debate, entitled ‘hedge funds: risk managers, not risky managers’, looked at ways to identify hedge funds as diversifiers in portfolios and identified issues surrounding operational and business risks related to hedge funds, in addition to investment risk.

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