BIS: GSIBs Risk IT Systems Weak

Unnamed GSIB Data Scientist /Risk Manager Demonstrates New Techology

In January 2013, the Basel Committee published the Principles for effective risk data aggregation and risk reporting (the “Principles”) to remedy deficiencies in risk management disclosed by the 2008 “Great Financial Crisis” (first euphemism of the post).  G-SIBS (Globally Systematically Important Banks) identified in 2011 and 2012 were required to fully implement the Principles by January 2016.

The BIS explained its action as follows:

“One of the most significant lessons learned from the global financial crisis that began in 2007 was that banks’ information technology (IT) and data architectures were inadequate to support the broad management of financial risks. Many banks lacked the ability to aggregate risk exposures and identify concentrations quickly and accurately at the bank group level, across business lines and between legal entities. Some banks were unable to manage their risks properly because of weak risk data aggregation capabilities and risk reporting practices. This had severe consequences to the banks themselves and to the stability of the financial system as a whole.”

In March this year, the BIS issued a progress report on implementation of the Principles.  Italics courtesy of AA.

“The latest assessments by supervisors show that banks’ level of compliance is unsatisfactory and the overall implementation progress remains a source of concern to supervisors. Based on supervisors’ assessments, only one bank fully complied with the Principles, even though the implementation deadline for global systemically important banks (G-SIBs) identified in 2011 and 2012 had lapsed in January 2016. In view of the unsatisfactory assessment results, banks are urged to step up efforts to comply with the Principles. Supervisors are expected to monitor progress and call on banks to address observed weaknesses.” 

There were some 28 G-SIBS as of November 2012. 

One out of 28 is roughly 3.6% compliance.

Not a very impressive performance from these megabanks who tout their capacity to provide state-of-the-art banking services based not only on their self-proclaimed profound intelligence but also their ability to perform complex mathematical analyses and calculations. These are also the same banks that have convinced their regulators that their internal risk models are sufficiently robust so that they should be used to determine their “true” exposure to various risks and, thus, their required capital under the Basel Framework.

The BIS progress report indicates that these self-assessments may be “overly optimistic” (second euphemism of the post). 

What’s even more disturbing is the BIS assessment of the reasons for the failure to reach compliance. You can read that in detail in Appendix 2.  Here’s the BIS’s take on “technical shortcomings”.

“Difficulties in execution and management of complex and large-scale IT and data infrastructure projects, such as resources and funding issues, deficiencies in project management, and coordination with other ongoing strategic programmes.

Overreliance on manual processes and interventions to produce risk reports, although some manual processes are unavoidable.

Incomplete integration and implementation of bank -wide data architecture and frameworks (eg data taxonomies, data dictionaries, risk data policies).

Weaknesses in data quality controls (eg reconciliation, validation checks, data quality standards).”

On a positive note, the BIS may have just supported US corporation and banks’ contention that they are incapable of determining the ratio of their CEO’s pay to the average for all other employees.

If we accept that as a working hypothesis, would you buy a product or place a deposit with a bank unable to measure its risk exposure or perform simple math (Dodd Frank)?

Simple Math Stumps US Corporations - SEC Rides to the Rescue

Our Corporations Isn't Learning

As you'll recall, Section 953b of the Dodd Frank Act requires corporations listed in the USA to publish a ratio of the total compensation of the CEO to the median compensation of all other employees (excluding the CEO).

Self-proclaimed "captains of industry" objected to the onerous requirement of providing this ratio, but their pleas were ignored --though implementation was delayed till 2017.

Now with a kindler gentler administration in the White House and control of both the House and Senate in the hands of the GOP, they are getting a second hearing.

February 6 Acting SEC Commissioner Michael Piwowar:

The Commission adopted the pay ratio disclosure rule in August 2015 to implement Section 953(b) of the Dodd-Frank Wall Street Reform and Consumer Protection Act. The rule requires a public company to disclose the ratio of the median of the annual total compensation of all employees to the annual total compensation of the chief executive officer.

Based on comments received during the rulemaking process, the Commission delayed compliance for companies until their first fiscal year beginning on or after January 1, 2017. Issuers are now actively engaged in the implementation and testing of systems and controls designed to collect and process the information necessary for compliance. However, it is my understanding that some issuers have begun to encounter unanticipated compliance difficulties that may hinder them in meeting the reporting deadline.

I encourage commenters and the staff to expedite their review in light of these unique circumstances.

Boldface above courtesy of AA.

Yes, this is indeed an almost insurmountable task. 

1. One has to figure out the total compensation of the CEO.  Oh, wait.  That's already done for the annual Proxy Statement. 
2. Then one has to figure out the median salary.  That's even more tricky because it involves two really "hard" steps.  
3. Big corporations have operations all over the world and pay their employees in a myriad of currencies.  How possibly could they figure out the US equivalent of Paris-based Jacques' salary or Frankfurt-based Heinrich's?  Oh, wait.  Corporations routinely convert local currency transactions into US dollars for their annual financial reports, including salaries paid to foreign workers.  Corporations also routinely keep detailed employee by employee payroll records for tax, pension, and other purposes so no new records have to be created.  What probably would be required is to add a column to figure out the US dollar equivalent salary for each employee.  
4. But, as no doubt many a beleaguered corporation will point out, then they have to figure out the median salary.  What's a median? An extremely challenging task.  One lists all salaries and then picks out the one that is smack in the middle.  This is the sort of things that computers were made to do.  Microsoft's Excel has a preprogrammed "median" function so this is definitely not rocket science.
5. So the corporation would have to consolidate US dollar-equivalent lists of salaries prepared by various operating units (foreign and domestic) and then sort them by amount and pick out the median.  Another automated process.

On its face, it sure looks like this objection is motivated by a desire to avoid providing this information because it's likely to raise uncomfortable questions about CEO compensation.

But, let's accept the manifest absurdity of this argument and assume for a moment the objection is true.  After all, we have a new Treasury Secretary who swears he can't fill out government ethics forms and other members of the Administration see things that never happened (3.5 million people at the Mall for the Inauguration, 3.5 million illegal voters, etc). 

On that score Mr. Piwowar "understands" that some corporations are having a problem.  It's not clear if there have been many complaints from companies, whether he is seeing things, heard about it from KellyAnne, or read about it on Breitbart.

Rule 953b was finalized 5 August 2015. 

That means that some US listed corporations have been unable to establish a system to calculate this ratio in the 17 months since then and believe that they will be unable to complete it in the additional 11 months remaining during this year (assuming most corporations have a December fiscal year end).

If this is the case, then 3 troubling questions.

1. In an era where complex calculations are at the base of product development and production, should a consumer purchase a product from a company that acknowledges its inability to do simple maths?
2. In an era where proper pricing of products, operations and risk management depend on the ability to perform complex calculations, should an investor buy the stock or bonds of a company that admits that simple mathematical procedures exceed its competence?
3. Should the average citizen and our government be worried that our self-proclaimed math-challenged corporations are clearly not equipped to compete with foreign corporations?

The SEC is taking comments on implementation of this rule.  Let your voice be heard.