When the COVID-19 crisis is over, or more likely being effectively managed, one of the many post-mortem exercises that will be performed is the impact of home-working and social-distancing on risk, particularly operational risk.
In 2002, I was working in a huge American investment bank as a relationship manager. My clients were all investment managers owned by insurance companies – some of the biggest buy-side firms in the world. One of the key skills of being an effective relationship manager in a bank that has a strong risk management function is to know how to navigate the many intricacies of bringing in new business.
Risk management teams are often portrayed as the “fun police” or business-prevention officers because of the bureaucratic obstacles they often bring up. But in reality, they are here to protect us.
2002 for us at the bank was dominated by the collapse of WorldCom — it zapped quite a lot of our bonuses. This was especially painful because the prior year Enron’s collapse had done exactly the same thing. But, for the bank, it could have been worse. A colleague and friend, we’ll call him ‘Steve’, was the risk officer at the time who signed off payments in the banks paying agent business. This is a non-glamorous but reliable segment: it has low-margin annuity-like revenues. The bank was paying-agent for a WorldCom bond issue and he was reviewing a list of coupon payments the bank was due to make on their behalf to the bond-holders. It was normal practice to make these payments whether or not the client had paid the money to the bank. Unofficially and informally, the client was often being given a credit-line, sometimes totalling many millions of dollars.
At the time there had been some speculation in the media about the soundness of WorldCom’s finances. Speculators were shorting the stock. But there was officially no reason why the bank couldn’t make the payments and expect the client to pay the money in. But Steve was suspicious and decided he’d do a bit of digging. The bank also had a huge bond-trading team and Steve sought out the traders who focussed on the telecoms segment. The information they provided was alarming. The message was that the speculation was well-informed, the finances were indeed flaky, and if you had an exposed position to get out as soon as possible. Steve immediately halted the payment – and saved the bank a huge amount of money. The client went spectacularly bust very soon after.
The key point of this story is that the conversation between Steve and the bond-traders took place face-to-face on the trading floor. If he’d been at home in Hampshire and the traders had been in their riverside apartments would it have happened? I doubt it.
He didn’t know who to talk to – he had to seek them out - but he knew where to find them. His instinct and his choice to have a physical conversation saved the day. A phone call or, even worse, an email would have had a much lower chance of being effective.
During the COVID-19 lockdown, there have been two prominent operational issues that have made headlines. A massive US bank mistakenly paid out $950 million to bondholders. To date, it doesn’t appear to have got all of it back. And it hasn’t explained what happened – other than talking about human error and manual processing. Attributing the issue to working-from-home is speculative but has to be a possibility. And, in Europe, the European Securities and Markets Authority (ESMA) has also reported that settlement fails in Europe spiked very sharply in March at the onset of the COVID-19 crisis. Fails climbed to around 14 percent for equities and close to 6 percent for government and corporate bonds. ESMA explicitly says that the problem was caused by “remote work and third-party outsourcing to countries in lockdown”.
Firm conclusions with such little evidence are premature but it does seem very likely that physical separation has had an impact. It is commonly asserted that old-tech and fragmented legacy systems in the middle and back-office are the root cause of operational problems. But what we’ve always taken for granted is the ability to overcome an issue by a face-to-face conversation. The best middle-office staff are not afraid to stand over a trader and tell them they have to help resolve an urgent issue. It is very hard, probably impossible, to be so persistent on Zoom.
It seems absolutely clear that we’re not all going back to the office in the way we did before. We will have to get used to offices being re-labelled as “collaboration centres” and making appointments to meet people we used to see every day. Compensating for the benefits of physical proximity with online tools is going to be very difficult. Is it even possible? What is needed now are tools that specifically focus on real-time verbal and visual problem resolution in a physically distanced model. An informal model will not cut it.
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