Post-Lehman, risk information has been in high demand. Still, there seems to exist a “risk gap” among risk managers and risk takers including fund managers and traders in the front office who continue to view risk management as an ‘after the fact’ middle office reporting routine for investors and regulators.

In effect, many risk takers are still not making full use of risk information on a pre-trade basis and are thus not integrating risk into their investment decisions. Until the value of good risk management is effectively championed throughout the organization, traders and portfolio managers who are not already risk-aware will continue to go about their business as usual. That is until an unexpected risk exposure signals the end of their good run and makes them wonder where it all went wrong.  

The need to create a culture of risk within firms is a recurring theme we encounter when speaking with our customers, who range from asset management firms in Australia to broker dealers in the USA. This poses the question, is creating a risk culture a top down or bottom up approach?

The question of how to create a risk culture permeates all levels and functions in an institution. While a top-down approach driven by senior management will ensure that all staff are aware of the value attached to risk management by management, this strategy is likely to result in a compliance-focused risk culture that is validated by the written and spoken word, rather than by everyday actions.

Yet a ‘bottom up’ approach that relies on risk managers taking the lead in creating a risk-aware culture is doomed to fail if they do not have the support of the firm’s senior management and front office ‘rain makers’.

This starts at the top with senior executives including CIOs acting as risk management “champions,” ensuring that all investment decisions are evaluated on a consistent risk-adjusted, with an appreciation of all the relevant risk exposures and a clear view of a range of both upside and downside scenarios, rather than being driven by prescriptive regulatory requirements. This way CIOs, CEOs and risk managers will be provided with a practical guide to creating an organizational culture that puts risk as well as return considerations at the core of all investment decisions.

Since the beginning of the financial crisis in 2008, many observers have argued that an over-reliance on risk models and risk measures like VaR have contributed to the financial crisis. In my view, good risk management starts with a culture that encourages risk and return to be seen as one, rather than separate aspects of the investment process.