Brian O’Donnell, executive in residence at celebrated risk management institute, Toronto-based Global Risk Institute, argues that pension funds need to adopt clear risk strategies to deal with cyber security, climate change and escalating financial risk.
In a webinar hosted by the International Centre for Pension Management titled ‘Risk Governance: Developing an Enterprise Risk Management Framework and Managing Emerging Risks, ranging from Climate Change to Cyber Threats’, O’Donnell draws on his long career in Canada’s financial services sector to highlight today’s most important risks.
He illustrates the growing risk of cyber security with examples of recent breaches in financial services.
The 2015 cyber attack on Japan Pension Services, a government-run agency that manages the public pension system, revealed the personal details of 1.25 million beneficiaries; JP Morgan fell victim to the largest theft of customer data ever in 2014 when hackers revealed personal information of 70 million households and 7 million small businesses; in February this year a cyber attack that investigators have linked to hackers in North Korea drained $81 million from the Central Bank of Bangladesh.
Moreover, it is a risk that is set to escalate with the rise of quantum computing. As computing grows faster and stronger, he believes it will render today’s cyber security “obsolete”, requiring a “quantum defence” to meet the massive increase in computer capacity.
Canada’s pension funds perceive cyber security as a “key risk” to “manage and take seriously”, and he urges the global industry to work as a group and share information to combat cyber crime. There is no benefit in working alone because hackers look for the weakest link, he says. “In Canada, we are all in it together.”
He says that recent cyber attacks should “plant the seed” for pension funds to think about their critical infrastructure risk, and ensure they have a cyber security framework in place.
He highlights the questions executives should ask: “Do we have a formal cyber security framework? What are the top five cyber risks we face? How are employees made aware and trained for their role? Are roles and responsibilities clear? Do we have a response protocol in the event of an attack?”
Climate risks growing
O’Donnell calls climate change “a very serious and significant risk of our time” and urges executives to understand the portfolio risk it holds.
He divides these risks into physical (physical damage to pension fund assets), regulatory (stranding and devaluing of carbon assets), systemic (broader shifts in the market place), and liability (the fiduciary responsibility to manage these risk and to rebalance to manage risk.)
He also draws attention to lessons that the pension industry can learn from the insurance industry.
“There are significant statistics from the insurance industry on physical risk like weather-related damage to buildings,” he says. “If I was a pension fund, I would wonder what this means for the assets I own. Do I have sufficient insurance in place and are my counterparties strong enough? Should I hold assets less susceptible to risk?”
O’Donnell’s third emerging risk is financial, caused by the growing asset bubble and “debt in the system” that has grown since the financial crisis. He notes that “exploding” global debt levels have risen from $150 trillion in 2007 to more than $200 trillion in 2015, and estimates that China’s debt has quadrupled since 2007 to $28 trillion.
It’s a problem that has been fuelled by low interest rates and quantitative easing, and now depends on policy from the US Federal Reserve to solve. “The real question is what will this mean when the next recession hits? If the next recession is steep and violent, how do firms start preparing for this today?” he asks.
In among today’s risk he also notes opportunity for investors in big data. The volume and variety of data coming out of financial firms and stored for analysis will increasingly inform strategy. Data scientists can analyse data to “look at what is happening in the economy”, understand cash flows and “do a better job” of credit analysis, he says.
Central risk culture
O’Donnell believes pension funds can manage risk if they build a strong link between their investment strategy and risk appetite.
A “central risk culture” should lie at the heart of an organisation, something he identifies as behaviour, values and systems: behaviour is characterised by actions of the CEO and values by how an organisation deals with challenges. Systems include a clear accountability of risk.
“Who owns the risk? Everyone should understand their roles and responsibilities. Risk appetite should be fully imbedded; it’s not just a glossy piece of paper but needs to permeate through organisation.”
He characterises risk appetite as the maximum risk an organisation is comfortable taking and risk capacity as the total amount of risk an organisation can take in light of its balance sheet.
“The weakness of risk culture caused the Great Financial Crisis,” he says, and adds that a “broken risk culture” is one that spirals into a blame culture, where difficulties and challenges are met with “pointing the finger.”