The core characteristics of healthy and vibrant futures markets are that they are (1) transparent; (2) highly liquid; (3) efficient; and (4) safe, fair and reliable. We can apply these same characteristics to improve risk management capabilities and processes in any organization. In this two-part series, we will describe these characteristics and suggest some practices on how to apply them to improve risk management and strategy within your own organization.
In Part 1 of this column, we discussed how organizations can leverage two of the qualities, transparency and liquidity, that typify healthy and vibrant futures markets to improve the risk management and strategic processes of their own organizations.
Transparency and liquidity are the two most obvious core principles that enable healthy futures markets. However, they would not be possible if the markets were not efficient, or safe, fair and reliable.
Efficient. If you have ever visited the physical trading floor of a futures exchange, the word "chaos" would likely come to mind far before "efficient," especially if you are visiting right before the closing bell. There is a lot of shouting, often frantic waving of arms and hands. Everyone is dressed in different color jackets, surrounded by computer screens and wall boards, and small scraps of paper are scattered all over the floor. All of this creates a mishmash mosaic of humans interacting with each other.
Underneath all of that apparent "chaos," though, there is tremendous order, enough to enable market participants to trade millions of futures contracts and transfer trillions of dollars of risk each and every day.
Where does the order come from? It comes from an extremely efficient structure and system of standard rules, protocols and processes that everyone that participates in the market (no matter their roles) understands and consistently follows.
Efficiency is also essential to effectively manage risks and set strategy in an organization--both of which boil down to how efficiently an organization can make a decision while appropriately considering any significant uncertainties.
Does your organization have an efficient structure and system of standard rules, protocols and processes that everyone in the organizations (no matter their roles) understands and consistently follows when evaluating and considering uncertain variables as they make decisions and take actions?
Most of us would probably answer this questions with a sheepish "somewhat" or just an outright "no." If you are in one of these two buckets, then look for and act on opportunities to improve the efficiency of your organization's risk management and strategy setting processes.
A good foundation for efficiency is a common structure; commonly understood terminology; and a straightforward process for identifying, characterizing, evaluating, monitoring and escalating uncertainties. For instance, does everyone have the same, consistent definition for "risk"? If not, either convert everyone to a consistent definition, or try my preferred approach and begin using another word that is more consistently understood (e.g., "uncertainty").
Safe, fair and reliable.
People come to futures exchanges to transfer risks because they are confident that their transactions will be safe, fair and reliable. Exchanges are structured and operated with these tenants top of mind. Every market participants depends on the safety of their trades and finances that are passed through the exchange. They also depend on their trades being matched and processed fairly and consistent with the rules of the market. And finally, they count on the infrastructure and technology underlying the exchange to reliably function and operate.
Safe, fair, and reliable are qualities that are also essential for effective risk management and strategy in any organization. If people don't trust the safety, fairness and reliability of the processes, then they will be less likely to participate and share their true views on uncertainty. If they don't participate, you lose liquidity. Or, if they participate but don't share their true views, you lose transparency. Both are bad outcomes.
As we all know, one of the easiest way to erode the elements of a safe, fair and reliable risk management or strategic process is to "kill the messenger." The easiest way to promote these important characteristics is for the top leadership of the organization to articulate, regularly reiterate and consistently act in line (i.e., practice what they preach) with these principles.
Organizations across the globe use futures markets to transfer trillions of dollars of risks each and every day. They are able and willing to do so because these markets are (1) transparent; (2) highly liquid; (3) efficient; and (4) safe, fair and reliable. Sure, most of our organizations do not deal with trillions of dollars of risk each day; however, we can apply these same characteristics to improve our own risk management and strategic processes. Give it a shot.
(Editor's note: Read the first part of David's column on what risk managers can learn from futures markets here.)
DAVID M. WONG is director of enterprise risk management at CME Group, the world's largest and most diverse derivatives exchange.
July 23, 2010
Copyright 2010© LRP Publications