Bubble Risk

A bubble occurs when there is a sustained rise in price of something beyond what you might believe is its normal value.  It occurs when people believe that the price will continue to rise, and so it does rise… until it collapses.

In the early 1700s, the South Sea company was established in London to trade with South America and the Southern Pacific Ocean.  One problem was that Britain was at war with Spain at the time, and Spain controlled most of South America, so no trade there then.  Nevertheless, the shares went crazy, and then they crashed with many people losing fortunes.

Early Warning Indicators (“EWIs” – also known as Key Risk Indicators or ‘KRIs”) can forewarn of when a bubble might burst.  Excessive house prices are a constant concern in a lot of major cities, and the bank UBS produces an annual survey of real estate bubble risk.  The survey covers 24 world cities and uses 5 indicators, including price to income ratio, change in mortgage levels to GDP, and price to rental value. It then combines them into a single value that can provide an overall assessment of where house prices are at in a particular city.  Combining indicators into a single value involves weighting the component indicators, and it can provide a powerful, single measure to enable you to discuss the likelihood of a risk crystallising.

One of the findings this year is that price to income has risen – overall prices currently reflect 7 years’ income when last year it was only 5 years; so house prices have become less affordable at the overall level.  The current hotspots are Munich and Toronto, with the only major city where real estate is deemed to be “undervalued” is Chicago.  Meanwhile, London has retreated from “bubble risk” last year, to just “overvalued” in 2019, owing to concerns around Brexit.

Data Sources: Fortune magazine, ubs.com


Disrupt yourself

In order to improve not little by little but by big leaps, you can disrupt your own operation.  Try changing some aspect of the operation radically, perhaps addressing the weakest aspect or where customers are least happy.  This amounts to actively taking operational risk and so needs to be understood, assessed, with assumptions tested, and managed through very carefully.  And there is always the risk that if you do not disrupt yourself, others will.

It may seem strange, but chess provides a good example.  Chess came to Europe via the Moorish invasion of Spain in 711 AD and spread quickly.  The name originates from the Sanskrit word Chaturanga which references the four components of an ancient Indian army: the infantry (pawns), the cavalry (knights), chariots (rooks), and elephants (bishops – the Spanish for this piece is “alfil”, a derivative of “elefante”).  The other pieces were the king, and then the vizier or adviser which could only move one square at time, and only diagonally.  Chess was at that time, a very long drawn-out game.

In the fifteenth century however, the Spanish replaced the adviser with a new, female, all-powerful piece – the queen.  It is said that this was to honour Isabel of Castile who had overseen the reconquest of Spain from the Moors, and backed Columbus’ westward voyage when others wouldn’t.

The queen was a game-changer – literally.  It made the game faster and more exciting.  And the new version quickly overtook the old.

Source: El País




Know Your Enemy

In the time of the Roman Empire, when the Romans came up against a tribe that they could not beat, they would make a truce.  As part of the truce they would exchange hostages, specifically the young sons of kings, nobles or leaders, for a period of years.  It was understood that if one side broke the truce, the other side would kill the hostages.

But for the Romans, there was more to it.  They took the enemy hostages to Rome and gave them a life of luxury in order to soften and debauch them before they returned to their homelands.  This would weaken the enemy when they took up their leadership role.  And on the other side, the young Roman hostages who were handed over to the enemy tribes had been briefed to learn everything about the enemy that they could, in order to understand their strengths and their weaknesses.

In the late 4th century AD, the Huns had moved into Europe with fast moving cavalry, living off what they could pillage and tributes they could exact from weaker peoples.  They soon became an issue for the Roman Empire that had by then split into an Eastern Empire based in Constantinople, and a Western Empire based in Rome, which then moved to Ravenna when Rome was sacked by the Vandals.

In the early fifth century, a powerful Hun leader emerged whom we now refer to as Attila the Hun.  Attila’s edge was that he had been a hostage in Rome, and had understood what the Romans were trying to do.  He resisted the life of luxury, and instead learned everything he could about the Romans.  He soon became the scourge of the Roman Empire, defeating its armies and exacting huge payments in gold in return for peace.

Attila only ever lost one battle against the Romans.  He had invaded Gaul (France) and was met by an army commanded by the Roman general Flavius Aetius.  It became known as the Battle of the Catalaunian Plains and took place in what is now the Champagne region of France.  The thing about Aetius was that he had been the exchange hostage going the other way, and spent time with the Huns as a teenager, understanding their ways.

In Aetius the Romans had someone who knew how to beat the Huns.  But the western emperor Valentinian III was jealous and fearful of Aetius’ growing reputation, and at a meeting with Aetius and the emperor’s advisers, Valentinian drew his sword and stabbed the unarmed Aetius, with the advisers then joining in.  Rome thereby lost its  best chance of defeating the threat from the Huns.  Sic transit imperium – thus empires are lost…


Source: “Attila the Hun” – John Man; Wikipedia.

Treatment time

When a risk starts to become unacceptable, and mitigations are not obvious, you need to look at other activities for ideas.

Antibiotics only became widely and cheaply available after the Second World War in the late 1940s, but now resistance to antibiotics is becoming a problem.  Currently, around 700,000 people a year die because microbes have become resistant to the antibiotics they have been prescribed.  It is estimated that this will rise to around 10 million people a year by 2050 with an economic impact similar to the last financial crisis.

One of the issues in addressing this risk is that pharmaceutical companies have pulled out of research into antibiotics because they can’t make money out of them. Indeed, one biotech company went bankrupt in April, not through poor management but because of how the market functions.

It takes around a decade to develop a new drug and about $1bn.  But doctors tend to use a new antibiotic very slowly in the first few years of its life in order to avoid the potential for resistance to develop.  So sales are low and slow, and that can be enough for companies to go bust and for investors to bail out of the market.  And so the flow of new antibiotics dries up, and microbes that have become resistant to current drugs kill more people.

One of the latest suggestions is to copy the Netflix business model, i.e. to charge a subscription and the purchaser (governments, hospitals, health insurers) can get as much or as little of the drug as they want.  So, the producers get a certain and consistent income, incentivising them to develop new treatments.  It may sound odd, but the model is now being used in America for drugs to fight hepatitis C.

 Source: The Economist magazine


An über-competitive market

In the 1620s, the profits of London water taxis were hit by the advent of Hackney carriages – horse-drawn taxis.  So many of them appeared that not only did each one not make that much money, but they also caused traffic chaos. In 1635, regulation was introduced to limit their number.

Competition is a risk you would expect to see on most organisations’ risk maps or registers, but the risk also needs to be really understood: exactly what is the competitive threat? how big is it? how probable is it that it will materialise? and what will it do to your business if it does?

One factor in competition risk is the ease with which others may enter your market, i.e. what are the barriers to entry?  In the taxi market, unless licences are limited in number for any given location, then it is relatively easy for anyone to enter the taxi market. As competition increases, discounts have to be offered to customers and profits vanish.  Generally, taxi earnings have only ever been maintained by regulation – for example, the medallion system in American cities like New York limited the number of yellow cabs, and consequently, individual medallions became very highly valued for the earnings they could generate for the holder.

Uber was set up as a “transportation network company” in 2009 and it now operates in 785 cities.  Since 2009, it has lost $7.9bn. And yet, it now plans to float its shares with a $100bn valuation.  Uber claims first-mover advantage in this market with its name becoming synonymous with the ride-hailing product.  It intends to move into autonomous vehicles (AVs) or robo-taxis,  and also to challenge car ownership itself (cars spend on average 84% of the time stationary, that is: parked up, not in use).   From this week, the Uber app includes live London transport data, letting you know the cheapest and quickest ways to get from A to B in London, including using private hire taxis – the idea is that the app may replace the need to own a car, and make the Uber app the place to  go to sort out your transport needs.

A lot of tech companies sustain long-term losses in order to reap eventual monopoly profits (think Amazon), and this is why investors stay with them.  But have Uber and its investors fully understood competition risk?  Well investors, including Toyota, have just put $1bn into Uber’s AV division.  How this pans out, and how regulation in different cities and countries will influence competition will be an interesting one to watch..


Source: The Economist, The Financial Times, Wikipedia


Twenty years on…

In 1999, the Turnbull report led to UK PLCs being required for the first time to perform risk assessments at least annually, or explain why they hadn’t done so in their annual report .

Banks were considered the leaders in risk management until a bunch of them failed in the 2008 financial crisis.

UK regulators require financial services organisations to operate a three lines of defence model for risk, comprising the first line business managers who manage their risks and operate their controls, the second line risk and compliance teams who coach, guide, facilitate and also challenge and oversee risk and control activity, and the third line internal audit who provide assurance to the Board that the risk management process is working.

However, by its very name,  the Three Lines of Defence model gives the impression that risk is wholly defensive in nature, it is about stopping negative things happening, and not about taking risk.  That is understandable, given the catastrophes, crises and corporate collapses of the last twenty years, however they keep on happening (think Boeing 737-800 Max, Carillion, Debenhams, etc) suggesting that risk management is really not that well embedded in business.  This may partly be because many people see risk management only as “business prevention”.

American football provides an analogy for the two distinct aspects of risk.  American football teams have separate teams for offense and defense (American spelling used).  When one team is in possession of the ball, they have their offensive team on the pitch, and the other side has their defensive team on the pitch. When possession changes the first team brings their offense off, replacing them with their defensive team; and the second team brings their offensive players on.

In offense, the team is trying to score.  In defense, they are trying to stop the opposing team scoring.

The defense consists of defensive linemen, linebackers, and defensive backs – possibly the origin of the Three Lines of Defence concept – three layers of control to prevent the risk of the opponent scoring.  If the defensive controls are not operating effectively on a regular basis, the fans would get angry and the coach might get sacked.  You could say that risk management is embedded in American Football and controls are taken seriously.

The offense also has controls.  The offensive linemen  are part of the offense but cannot move the ball forward, they are there to protect the quarterback, allowing him to make the play effectively, i.e. helping to ensure that the objective (scoring) is achieved.

In order for risk to provide reward, both offense (risk taking) and defense (risk detection and prevention) need to be given equal importance.

 Source: Wikipedia, GQ magazine


102 years ago, April 9th was a snowy Easter Monday in northern France.

April 9th is now Vimy Ridge Day, a national holiday in Canada.  It commemorates a World War One battle that took place between April 9th and 12th 1917.

Four divisions of the Canadian army, commanded by British Lieut-General Julian Byng, and supported by British artillery, tunnellers, and the Royal Flying Corps (the RAF would not be formed until April 1918) took an escarpment in the Calais region that had been held by the German army since 1914.

The escarpment dominated the surrounding area and the German position prevented an allied advance to retake French territory.  There had been previous attempts to take it by the French and British armies, but these had failed and had incurred huge numbers of casualties.

Whilst I would prefer not to use military analogies for risk, this battle featured an approach that was novel, and very different from the previous, horrific battles of WWI.  What was different about it was the following:

* The objective was clear – to take the escarpment. But then it was broken down into four key objectives, one for each division.  And then objectives were cascaded down to individual platoon level.  This was communicated throughout the divisions, supported by 40,000 trench maps that were distributed, so each platoon understood where they fitted into the overall plan.  The platoon became the basic tactical unit and that provided flexibility of action.

* The battle had been planned for months, using detailed analysis of what had worked and not worked in previous battles such as Verdun and the Somme.  The analysis was shared at a series of lectures.

* The battlefield was recreated in a plasticine model, largely based on aerial reconnaissance from balloons and planes (a dangerous activity in those early days – the other side had the fighter planes of Jasta 11 in the area, commanded by the infamous Red Baron).  The understanding of the battlefield was shared using the model.

* Miles of telephone cabling was laid at night to ensure battlefield communication could take place during the forthcoming battle.

* The key feature of the attack was a rolling barrage of artillery supporting infantry advances where platoons leapfrogged each other to maintain momentum.  This was both innovative and complex but was practised extensively on hills away from the battlefield, with the trench positions marked as lines of tape and officers on horseback indicating where the rolling artillery barrage would be landing.

* Platoon roles were shared; there were back-ups for each role – multiskilling in a word.

* The intensity of artillery firing was varied to confuse the enemy as to intention.  The level of artillery support was three times greater than on the Somme, a vital piece of learning from that disaster.

* The use of mines in tunnels was adapted for learning from previous battles – it created trenches in the battlefield that allowed safer advances, but avoided previous mistakes where craters were created which had simply signalled to the enemy where the advance was going to take place.

Four Victoria Crosses were awarded following the battle, and the General was made Baron Byng of Vimy.  There is now a large memorial to this battle at Vimy in the Pas de Calais.  And the coat of arms of the village has been adapted to include maple leaves.

 Source: Wikipedia, The Canadian Encyclopedia


The Tragedy of the Commons

Salted dried cod was found everywhere in Europe in the fourteenth and fifteenth centuries and was mainly supplied by Basque fishermen and merchants.  People wondered where they found such a plentiful supply.  It is now assumed that the Basques were fishing off Newfoundland long before the Italian John Cabot “discovered” it for the English Crown, and before Columbus bumped into the Caribbean.  The existence of Basque words in Newfoundland First Nations’ languages (including the word for cod) is a clue.  Shortly after Cabot claimed it for England, there is written record of 2,000 Basques living there, so the connection was probably already strong.  The probable reason that there is little documented proof of this is that the Basques kept the amazingly bountiful Grand Banks fishing grounds a secret.  They didn’t want anyone else getting in on the act and spoiling it.

Newfoundland became an English then British colony, and later became a dominion of the British Empire in 1907. Its great wealth was the fishery with almost the entire population involved in that industry.  In 1949, Newfoundland merged with Canada whilst quaintly preserving its own time-zone, half an hour ahead of the rest of Eastern Canada.

The fishery now came under the Canadian government which allowed unrestricted fishing for several decades; but in 1992, with the cod fishery below 1% of what it had been, and the by-catch (fishing the calepin on which cod feed and just throwing it away) having destroyed the ability for it to recover, the government closed the fishery down, putting 35,000 people out of work.  It has not re-opened.

The British economist William Forster Lloyd introduced the concept of “the Commons” in the 1830s as any shared resource which is open for anyone to participate in.  It refers to the old English custom whereby villages held common land on which anyone could graze their cows.  In 1968, the American ecologist Garrett Hardin wrote of the “Tragedy of the Commons” where everyone has access to a resource, but by each one maximising their own advantage, they actually end up destroying the resource itself.

Where there is a risk that is not owned by anyone, then no-one will probably bother to understand it, and certainly no-one will manage it.  Sooner or later, that risk will crystallise. The Newfoundland population now consists of those who live on government benefits or those that have been forced to emigrate to other parts of Canada and who only return for holidays.  But the cod have not returned.

 Source: “The Basque History of the World” – Mark Kurlansky; Wikipedia.

The Two Faces of Disruption

There are two kinds of business disruption.  One is where your systems go down, or a supplier fails, or your head office burns down.  For that you need resilience in the form of back-up and business continuity plans and arrangements.  The second type is where a new entrant to your market, or possibly a competitor, disrupts your business model by doing something radically different.  It is harder to plan for that type of disruption, other than to keep close to innovations in your market and to keep on innovating yourself.  Both types of disruption can destroy your company.

Google has just announced that it is going to enter the $135bn-a-year online gaming business with a streaming service called Stadia where players will be able to click on a link from a YouTube video to get into the game, and will bring new gaming experiences that cannot be matched by current hardware.  200m people a day currently access YouTube just to watch gaming-related videos.  Stadia will run on Google’s cloud computing platform and on their own fibre-optic cable rather than relying on the public internet backbone.  With a shift to cloud, gaming specific consoles would not be necessary, and that is the disruptive element.  Sony and Nintendo’s share price fell on the announcement.

Not all disruptions work for the disruptor.  Cloud gaming has been tried before and the company, OnLive, went bust seven years ago with patchy streaming and a lack of financial backing.  Google believes it won’t suffer from those problems.  But even then, the disruptor has to be careful not to be disrupted itself. It is believed that Amazon and the Chinese tech company TenCent are not far behind with something similar…

 Source: Financial Times

How much risk am I willing to take?

“If you don’t take risks, you will never drink champagne” is a proverb in a number of Eastern European languages.

It is an idea that seems to be driving people to risk their lives diving in the Baltic to dig up amber out of the sea floor.

Amber is highly sought after for jewellery in China.  And the centre of the world’s amber trade is Kaliningrad, a separated chunk of Russia (technically an exclave) on the Baltic Sea which holds around 90 per cent of the global reserves of the fossilised tree resin.

Up to 18 months ago, most of the amber going into the black market was just dug up on land, and the biggest risk was being caught by the police.  Then the government introduced new, higher fines for illegal mining.  So the diggers turned to diving to get it from the sea-bed.  The law is unclear as to whether this is illegal, but the risk is that you might die in the process, digging under 30 feet of water, clouded by the sand being dug, with the hole you dug liable to collapse on you at any moment.  And around a dozen people died doing just that in 2018.

In a region where 50% are unemployed, the lure of getting a product that can sell for $30 per gramme is deemed worth the risk when the alternative is going into the army and getting paid $350 a month – less than a tenth of what they could earn in a day digging for amber under water.

Risk appetite is often assumed to be just about how much risk you can tolerate, often in relation to costs, to downsides, and in those cases you want to stay well within your appetite limits.

But it should also express how much you are willing to take risk, and in those cases you are trying to get near the maximum – but not over it – to maximise the champagne.


 Source: Financial Times