#1: Making Good Risk Decisions
I have been asked how one becomes a good CRO a lot recently. Often the answers given can seem glib. Or be 'everything, everywhere, all at once' without picking where to focus.
So, on that note, here are some of my thoughts.
First you have to manage risk. You've got to stop the firm (firm, fund, institution, whatever) you're responsible for from blowing up or self-destructing. You've got to create resiliency. This is much harder than it sounds. I will return to resiliency in another note.
Next you have to have a plan. Risk is a scarce resource. You need to use your firm's willingness to take appropriate risks to help achieve it's strategic goals. And not other unimportant stuff. This is risk appetite and where to use it. This sounds glib too. I'll leave this for a later as well.
In the real world your risk appetite usage is built up of many risk decisions over time. So to do so well you've got to take good risk decisions on trades, investments, new opportunities and specific questions. But make sure each one is making a step along the strategic road set for the firm.
How do you take these decisions and make sure they are sound and appropriate?
First of all these types of decisions are likely to be complicated and have a lot of hair on them (I apologise for the slight allusion to black holes - I can't deny my past). So the first problem is making sure you see the wood for the trees.
A CRO will have experience in their field. They will generally have a sense of the areas that matter in any circumstance. Make sure you get an overview of the decision at hand. Step back. What does your intuition tell you? What is the thing nagging at you? This is the best guess of the crux of the trade (or whatever). Here is the point to concentrate. Be led to the crux of the problem by your intuition.
Remember, allow juniors to challenge and express opinions and new ideas. Make sure you have found the critical question by probing the people who have thought through the whole or part of the trade. But not too much - you have to trust in your team and show you trust them.
Now focus your resources on understanding the decision points around the crux. What do we know? What do we surmise? What might not be known? How different are the future outcomes? Here it is analysis and understanding that will lead to the decision point. But always make a decision - though this does not have to be exactly either yes or no; it can be an offer of differing terms. If it seems too close to call then consider which side has the positive convexity in strange or extreme situations and chose that side.
And let’s finish with some nostrums:
Too many controls creates complacency
Poor controls gives bad outcomes
Tick the box isn't as bad as it sounds, it can give efficiency when used in scale
But understanding is best
Use convexity and asymmetry to your advantage
Find the crux and decide
Lewis O'Donald
13th April 2023
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