Risk Management in the Age of Disruption

RISK MANAGEMENT IN THE AGE OF DISRUPTION

Moscow13 November 2015

FNA

Alan LaubschDirectoralan@fna.fi

Agenda

1. Adaptive Risk Management

2. Identifying Phase Transitions

3. Navigate Emerging Risk

s2015 Map of the Internet

Connected

Risk

Implication of Complexity

From “Predict & Control” to “Sense and Respond”

with Dynamic Steering

Seek to understand hidden fault lines…

While Qantas & CX rerouted, many continued business as usual: “We've flown this route for many years, it's safe and that's the reason why we are taking this route”

Source: BBC

Market linkages

Asset price data

Clustering

Balance sheet data

Financial Cartography reveals connected risks and hidden patterns

Bilateral exposure data

Central nodes

How to manage emerging systemic risk?As in healthcare, our best chance lies is early detection

Source: MULTIPLE SCLEROSIS: ORIGIN OF ABNORMAL CELLS FOUND, UC DAVIS (2011)

Adaptive Risk Management:Powered by Polarities

I. Macro: identify potential scenarios

See: Adaptive Stress Testing: Amplifying Network Intelligence by Integrating Outlier Information (Laubsch 2014)

II. Micro: monitor visible riskAmplifying tremors

Structural Risk

Diffusion of Disruptive Innovation

Source: Wikipedia; see Geoffrey Moore’s “Crossing the Chasm” (1999)

1.Macro: Scenarios from Innovators

2. Micro: Market signals from Early Adopters

U.S. Subprime Bond Early Warning Case Study

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-52.5%

0.0%

52.5%

105.0%

157.5%

Date

Spre

ad C

hang

e

300%+ increase in vol from Dec 12 to 21 '06

99% VaR bands vs 2006-1 AAA spread changes

HSBC subprime disclosure triggers a 12 sd move on Feb 23 '07, the day after the $10.5bn HSBC loss announcement

Ratings agencies initiate reviews and/or downgrades week of July 9 '07

Source: Alan Laubsch “Subprime Risk Management Lessons”, RiskMetrics

2. GS exits subprime (Micro)

1. Robert Shiller warns of housing Bubble in 2005 (Macro)

Three Stages of Risk

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125

250

375

500

Dec ’06: first tremor (vol up 300% Dec 12-21)

Feb 23 ’07: HSBC subprime loss disclosed

AAA Subprime Bond Spreads (2006-1) AAA) First ratings

agency downgrades week of July 9 '07

bp's

1. Hidden RiskInnovators

2. Emerging

Early Adopters

3. Crisis

Early Majority

Tipping Point Dynamics require early detection and action

Look for exponential rates of change

Source: “Building A Reputation Risk Management Capability”, Diermeier & Loeb, 2011Invisible/Potential Visible & amplifying

Agenda

1. Adaptive Risk Management

2. Identifying Phase Transitions

3. Navigate Emerging Risk

Dragon King (Sornette 2009)

Black Swan (Taleb 2001, 2007)

Two kinds of crisesWhat are you afraid of?

The future is already here. It’s just not very evenly distributed. - William Gibson

Energy Disruption: No escape for fossil fuels

Solar: Half way to 100%…

What precipitated Energy’s 24 June 2014 tipping point?

24 June Risky Business Report

Divestment Tipping Point

Disruptive Energy “Dragon Kings”

The future is already here. It’s just not very evenly distributed. - William Gibson

Alternatives

Divestment

Carbon Price

Nokia’s iPhone Moment

Tesla vs Model T trajectory

Media got Netflixed

Accelerating Rates of Adoption

Rise of the machines…

… and robo-advisors

Bank unbundling… and re-aggregating?

How important is Bitcoin?

“Like Internet in the 1990s…”

Agenda

1. Adaptive Risk Management

2. Identifying Phase Transitions

3. Navigate Emerging Risk

Key Risk Management Challenges

1. Dynamically monitor a complex environment• Systemic pressure points

2. Uncover key vulnerabilities• Macro scenarios, rapid & reverse stress tests

3. Make decisions• Risk culture and communication

Dynamic maps build environmental awareness for navigating challenging terrain

“MIT scientists develop Prometheus like environment scanner”Source: computerstories.net

Systemic implications?

Amplifiers?

Focus on systemic pressure points

Mass collaboration platforms empower social intelligence

“…if you have an idea and I have an idea and we exchange them, then we both have two ideas. It's nonzero.“ -- Dean Kamen (“Abundance” by Diamandis & Kotler)

Manage polarities for virtuous cycles

Outcomes reflect compounding feedback loops which create virtuous cycles or death spirals (“Rethinking capitalism,” Hanauer & Liu, 2012)

Conclusions: Key Polarities

• Fault lines & tremors

• Think big & move fast

• Core & Periphery

All interesting things happen at the edges of the system. They do not happen at the solid core. In the

edges where things are uncertain is where the evolution happens.

- Vinod Khosla

FNAAlan LaubschDirectoralan@fna.fi

Thank You