The Importance of Sound Risk Management
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Peter McCray
Deputy Chief Executive
Australian Office of Financial Management
The Importance of Sound Risk Management
- a better integrated, more cohesive management framework
- obliges a clear articulation of govt's risk preferences and its willingness to trade off cost and risk
- establishes a coherent basis for better long-term cost performance
The Importance of Sound Risk Management
- enhanced transparency, clear lines of accountability
- well-defined objectives
- cost and risk concepts, risk policies and procedures well defined and documented
- motives for operations clearer to all stakeholders
- sound basis for measuring and reporting performance
Marketing Risk Management Reform
- not necessarily a straightforward task
- a considerable departure from the 'traditional' approach
- political/budget management pressure to minimise current period debt service costs
- standard budget management framework focus on identifiable up-front savings as a pre-condition for new program spending
Marketing Risk Management Reform
- traditional approach often grounded in a short-term transactional focus
- consistent with a focus on the marginal implication of alternative transactions for debt service costs
- usually inadequate attention to government's risk preferences and risk trade-offs
- cost and risk concepts may not be well specified
- generally inadequate attention to risks to longer-term cost performance
Marketing Risk Management Reform
- better defining the traditional approach
- debt management task viewed as a series of discrete functions undertaken within only loosely-related 'silos'
- managing day-to-day liquidity needs
- achieving budget funding task
- operating objective might typically be pitched at minimising the budgetary cost of these discrete functions, perhaps even on a 'silo by silo' basis
Deficiencies of the Traditional Approach
- this functional view can be helpful in describing what a debt manager does
- but provides little insight into why particular strategies adopted / decisions taken / activities prioritised
- and seriously deficient as a management framework
Deficiencies of the Traditional Approach
- functional focus encourages an overly narrow notion of 'cost' and 'performance'
- e.g. cash management focus on minimising 'idle balances'
- e.g. issuing offshore in pursuit of short-term cost savings at the expense of developing domestic market liquidity
- e.g. building liquidity across the curve without proper consideration for portfolio interest rate risk
A Risk Management Framework
- a key insight is that similar or equivalent risks can arise in the conduct of a variety of financial functions
- provides a framework for 'looking through' the operations of seemingly quite loosely-related debt management functions to identify common risks
- Basle standards - the overall prudential standing of a financial entity can best be assessed in terms of its exposure to different risks and the effectiveness with which those different risks are treated or managed
A Risk Management Framework
- true of any economic entity with financial exposures in its balance sheet - including a sovereign debt manager
- risk focus provides a management framework for moving away from seeking to manage cost outcomes on a transaction by transaction basis
- towards addressing all relevant risks bearing on cost performance within a more transparent and coherent management framework
A Risk Management Framework
- a risk-based management framework requires identification of all relevant risks to cost performance
- market risk, funding risk, liquidity risk, credit risk, operational risk
- makes it clear in what areas the gov't is exposed in terms of inadequate capacity to manage these risks
- and, unlike traditional approach, makes it clearer that risks are not independent
A Risk Management Framework
- obliges conscious decisions as to the balance to struck between different risks, the govt's risk tolerance and it's preferred cost-risk trade-off
- clear that a 'do nothing' strategy is as much a deliberate choice about risk and risk preference as a decision to manage the existing risk profile
A Risk Management Framework
- does not eliminate risk nor provide for 20:20 foresight
- but provides a coherent framework for making choices about risk
- for selecting efficiently from among different risks so as to minimise risk overall in line with the govt's risk preferences
- makes it clearer to external stakeholders why it is that the debt manager may be prioritising certain activities
A Risk Management Framework
- a risk-based management framework is better geared to a more robust measure of debt management cost performance than the traditional functional approach
- obliges a focus on the full term implications of all risks to cost outcomes
- with all risks identified, extent of exposures will be clearer, as well as how effectively those exposures are being managed
- provides a sound basis for resource deployment and prioritisation
Conclusion
- a risk-based focus provides for a discipline and a rigour absent from more traditional approaches to sovereign debt management
- a more coherent management framework, greater clarity in objectives and risk policies, enhanced accountability
- and, ultimately, a much sounder basis for achieving better longer-term cost performance
