An international actuaries report has proposed a new global risk management framework to prevent future financial crises which includes stricter capital requirements for financial institutions with remuneration incentives focused “excessively” on the short term, and the appointment of a country chief risk supervisor. The report, written by the International Actuarial Association (IAA) and titled Dealing with Predictable Irrationality – Actuarial Ideas to Strengthen Global Financial Risk Management, calls for the introduction of counter cyclical regulatory arrangements which require changes in capital requirements when early warnings of bubbles emerge, and wider use of risk management concepts at a micro level.

Such moves would ensure individual entities such as superannuation funds and banks, as well as non-regulated entities, anticipate extreme events and more consistently measure and report on risk indicators, the IAA notes. Tony Coleman, chair of the IAA’s enterprise and financial risk committee, said remuneration incentives should be linked to risk culture to drive behavioural change. “Remuneration is a key driver of cultural change and so we support increasing capital requirements for market participants with remuneration incentives focused excessively on short term results,” he said.

He said bonus-type remuneration should not be focused just on one-year profit, but rather focused heavily on the longer term vesting of shares in the organisation over a three to five year time horizon. This way, even if a chief executive leaves an organisation, they may not receive the full value of their incentives until three years after leaving the firm. According to the IAA, risk management and co-operation between national jurisdictions would be improved through the creation of a chief risk supervisor, whose responsibilities would include developing an agreed risk appetite policy for key market-wide risk indicators, and monitoring and managing those indicators.

Coleman said the role would sit between the Reserve Bank of

Australia and the Australian Prudential Regulation Authority (APRA). Publicly reporting macro risk indicators and facilitating risk identification and communication with appropriate decision-makers at both the national and international levels would also fall within the supervisor’s remit.

The IAA has put forward a number of new “systemic risk indicators”, including: leverage in the economy (household debt/GDP); leverage in institutions (total assets/capital); volatility, turnover and bid spreads in major financial markets; credit spreads; growth in derivatives markets, particularly options; major changes (especially concentrations) in market sectors; real interest rates – actual or implied, and bonus levels paid by financial firms.

Join the discussion