FMP8 - Enterprise Risk Management and Future Trends

Question 1

Describe Enterprise Risk Management (ERM) and compare an ERM program with a traditional silo-based risk management program

Answer 1

ERM applies perspective to risks all over the firm, allowing it to see which risks may negate each other / exacerbate each other as in a traditional risk management system

Supports consistent management throughout the firm

Question 2

Describe the motivations for a firm to adopt an ERM initiative

Answer 2

• helps firm define and adhere to enterprise risk appetites
• focuses on most threatening risks
• optimises risk transfer expenses in line with costs and exposure
• manages risk concentrations

Question 3

Explain best practices for the governance and implementation of an ERM program

Answer 3

1. Targets - risk appetite and how it relates to strategic goals
2. Structure - role of the board and risk committee
3. Identification and metrics - measuring severity of risks
4. ERM strategies - how you are going to tackle the risks
5. Culture - setting common goals, practices, and behaviours

Question 4

Describe risk culture, explain the characteristics of a strong corporate risk culture, and describe challenges to the establishment of a strong risk culture at a firm

Answer 4

Risk culture is set of goals, values, beliefs etc that govern how employees create, identify, manage, and think about risk within an enterprise

Can be challenging as individuals will arrive in firm with own set of beliefs and have to absorb new behaviours, can create slight mismatches to desired behaviour

Characteristic of strong risk culture:
1. accountability
2. effective communication
3. incentives
4. tone from the top

Question 5

Explain the role of scenario analysis in the implementation of an ERM program an describe its advantages and disadvantages

Answer 5

Scenario analysis allows the firm to assess the impact of variables changing on the firm’s portfolios

+ challenges firms to imagine the worst and gauge effects
+ allows firms to focus on key risks and exposures
+ allows firms to identify warning signs and build contingency plans
- unfolding scenarios can become complex with many choices
- vary in terms of quality and sophistication
- difficult to gauge probability of events

Question 6

Explain the use of scenario analysis in stress-testing programs and capital planning

Answer 6

Scenarios built into Dodd-Frank Act stress tests (DFAST) and Comprehensive Capital Analysis and Reviews (CCAR) to allow firm to assess how the scenario will affect the bank over a long time horizon