Financial Crisis Dominates European Risk Manager Debates, Conference

One of Pat Oliphant’s more recent editorial cartoons shows presidential candidate John McCain held in the trunk of an enraged elephant labeled “The Economy.” “My friends,” says McCain to a bewildered Barack Obama and Sarah Palin, “kindly pay no attention to the elephant in the room.” However, that elephant is indeed in the room.

What started as a problem with non-performing subprime loans backed by mortgages in the United States has metastasized into the worst global economic crisis since the 1930s. Banks in the United States, Europe and throughout the world have essentially stopped lending money, either because they don’t have any, or they’re scared they’ll never be repaid. This has created a liquidity crisis that threatens to turn a recession into a full-blown depression, as businesses begin closing their doors for lack of funds.

While the candidates debate and the money managers scramble, one bailout after another is followed by continued financial collapse. The failure to control, or one suspects even to understand, the risks they were taking on led to the downfall of Bear Stearns, Fannie Mae, Freddie Mac, Lehman Brothers, Merrill Lynch, AIG and Washington Mutual in the U.S.

But, like the plague in the 14th century, the crisis spread. It hit the UK first, and then Continental Europe. The UK’s Financial Services Authority banned short selling of a number of financial stocks. Then Lloyds TSB Group agreed to rescue rival HBOS, scooping up the UK’s largest mortgage lender. The British government stepped in to rescue mortgage lender Bradford & Bingley by nationalizing it.

Belgium, the Netherlands, France and Germany also faced problems with their banks. Fortis, the largest employer in Belgium, went through several rescue plans. The Dutch government backed out of one deal, and then nationalized its portion of Fortis. The Luxembourg and Belgian units were in turn nationalized by their respective governments, and Fortis insurance operations in the countries were subsequently sold to French Bank, BNP Paribas. Germany is still trying to figure out how to rescue lender Hypo Real Estate after German banks and insurers pulled out of a state-led $48 billion deal to take it over.

With an elephant that large in the room, even well organized risk management conferences cannot help but become involved in the discussion. Europe’s largest companies take risk management seriously. The risk managers from many of them, who recently attended the Federation of European Risk Management Association’s (FERMA) conference in Brussels, appeared appalled at the increasing financial firestorm ravaging their banking colleagues, and one of their biggest commercial insurers, AIG.

Although the economic crisis wasn’t on FERMA’s official agenda, it was definitely on most people’s minds. Along with the meltdown of AIG, the ongoing problems at Fortis and the French-Belgian bank Dexia, were being played out simultaneously with the conference.

The first day agenda concentrated on European Community (EU) legislation, as propounded by the European Commission (EC), the EU’s rule making authority. The Solvency II financial regulations, which are due to go into force in 2012, topped the list, with a special focus on what special regulations should be adopted for captive insurance entities.

The current crisis in the banking sector, however, served to underscore the need to assess risks as realistically as possible, which Solvency II is designed to do. In retrospect it appears that the Basel II regulations, which govern the EU’s banking sector, have failed to protect it from the effects of the crisis. That Solvency II regulations must be drafted in such a way as to avoid making the same mistakes is now self-evident.

The financial crisis leitmotif first surfaced in the opening remarks by Thierry van Santen, Group Danone’s corporate risk manger, and FERMA’s past-president. He said that AIG’s meltdown was “unanticipated,” but it now appeared to be part of a “worldwide financial hurricane.”

AIG’s fall surfaced again in connection with Solvency II. Paul Taylor, FERMA’s Vice President, and a board member of AIRMIC, the UK’s risk management association, asked Ben Carr, of the European Commission, if AIG would have met Solvency II requirements. At first glance the answer would be yes. But the question is more complicated, as the discussion that followed showed. Taylor pointed out that AIG’s failure had little to do with its insurance operations, and everything to do with its financial ones, specifically the immensely leveraged operations of its London-based subsidiary AIG Financial Products. The unit essentially traded on AIG’s “AA” ratings to make huge bets on derivatives without putting up hardly any cash. When called on to do so, the ensuing domino effect scuttled AIG.

Under the current banking rules, and significantly under Solvency II, as currently proposed, AIG’s more esoteric units would not come within the ambit of the regulations. As a conglomerate, only portions of its activities, mainly its insurance operations, are regulated. A number of its other activities are not. “So many companies were caught off guard,” was the way FERMA vice president Frank Baron put it in discussing the global economy.

“Enterprise risk management starts with understanding what you [the company) do,” said Van Santen.

The European business community, and certainly company risk managers, is increasingly concerned not only as to how the financial crisis can be managed, but also what the fallout from it will be. If global consensus cannot be achieved on regulating the world’s financial markets, each country, or economic block may feel impelled to create its own regulations.

Europeans are especially concerned that the U.S. will go into another paroxysm of rule making, as it did after the Enron, World, Com, etc. scandals when Congress enacted the Sarbanes-Oxley (Sox) regulations.

Since FERMA’s conference the elephant has gotten bigger and meaner, with stock prices falling around the world and economies continuing to contract.

Topics USA Legislation Europe Training Development AIG Risk Management Germany