Op risk secrets

Industry keeps quiet about op risk insurance and risk transfer mechanisms

I know that journalists often have a hard time digging up stories but I had become used to the friendly, close-knit operational risk community happily relating their tales to me. So, when lately, on the particular issue of attaining capital relief from risk transfer mechanisms, the industry seems to have closed ranks on me, I was a little surprised. Could this be a knock-on effect from the industry being put under increasingly more pressure to demonstrate their business value? Understandably gaining a cut of up to 20% on your regulatory capital can be seen as being a major business advantage. It also has the added bonus of proving the effectiveness of op risk management as something other than as a compliance exercise. But two things are clear: no bank should expect to get a cut beyond 10% due to haircuts and other restrictions, and that it would actually be to the benefit of the industry if banks spoke more openly about their insurance programmes to help engage the insurance industry to come up with more Basel-compliant products.

The real reason for all this secrecy of course is the fact that it has the potential to create a new market for operational risk hedging products. Two capital market structures are ready to go apparently but there has been no news yet on how investors have responded or indeed if the regulators will approve the structure. And there are still so many unanswered questions about how the products will work in practice, mostly around how to price them and what the triggers would be. Work is being undertaken on creating an op risk index that would help set triggers but the details surrounding this project are hazy. Are we really on the cusp of a new phase in operational risk management, where op risk derivatives will finally become a reality? In the words of one close friend of the magazine, “Insurance for op risk will come into full swing right around the time that pigs fly or the Loch Ness monster is found.” I disagree but would love to hear your thoughts so please get in touch.