Anselmo L S Teng: Risk and compensation management
Opening remarks by Mr Anselmo L S Teng, Chairman of the Monetary Authority of Macao, at
the Macau Management Association (MMA) 2008 Annual Management Conference, Macao,
14 June 2008.
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Council Chairman Lau
Distinguished Guests
Dear Delegates
Ladies and Gentlemen,
Good morning!
1. I am honoured to be invited by the Macau Management Association to make an
opening remark in this conference, the theme of which, "Navigating Complex
Changes through Corporate Strategies", is most timely and relevant, especially
when organizations, big and small, are facing a lot of threats and challenges, both
internal and external, under a globalised environment nowadays.
As you are aware, the business definition for corporate strategy is the direction an
organization takes with the objective of achieving business success in the long term.
I'll use the sub-prime fallout as an example to illustrate two important aspects within
corporate strategies, i.e. risk related aspects and human resources related aspects.
2. The turbulence of the international financial markets caused by the subprime fallout
will probably linger for another 1-2 years. The rescue actions adopted by central
banks of the developed economies have prevented a major financial calamity from
happening but the impact on global economy and financial markets will remain for
quite a while.
There is no exact figure for overall subprime losses. The estimates made by
financial experts and international institutions range from USD400 billion to USD1
trillion. The losses will be borne by financial institutions and individual investors. The
investors who have suffered losses will inevitably cut back investment and perhaps
consumption. The losses incurred by financial institutions of the developed
economies however have inflicted more serious repercussions. The immediate
effect is the overall shrinkage in liquidity in the international financial markets. The
most devastating impact is the reduction in lending capacity of financial institutions
as the write-off and provision of delinquent loans and/or investments directly eat into
the shareholders' fund of a financial institution.
3. After the subprime crisis, financial experts around the world have started to find out
the reasons why it happened and proposed ways to prevent similar mistake from
happening again. There are a lot of findings but they all boil down to a big topic -
"risk management". In the past few years, financial and technological innovations
have given rise to a number of subprime related products coming from financial
institutions. These included subprime loans, collateralized debt obligations (CDO),
structured investment vehicles (SIV) and other exotic financial products. As a matter
of fact, a large number of risk management tools such as risk management models,
ratings, credit default swaps (CDS) did emerge in the subprime cycle. But
unfortunately fallout still occurred which in essence reflected inadequate risk
management. Financial post mortem analysis has suggested that financial
institutions who have suffered seriously from subprime fallout have failed to mitigate
a number of risks, such as market risk, liquidity risk, concentration risk and counter
party risk etc. That is to say, the corporate strategy in so far as risk mitigation is
concerned was incomplete, untimely and was not commensurate with its business
profile and development. As financial institutions, or organizations with different
business nature, offer more sophisticated products and services in order to achieve
business success, there will be more associated risks in their on-going risk
management framework. This is particularly true as they grow in size and
complexity, and their ability to identify, define, measure, manage, and organize to
manage their risks; and how to reflect all those elements as appropriate in the
corporate strategy is of utmost importance.
4. Besides risk management, however, there is also one aspect which can apply to
management of virtually all trades.
The human resources part of corporate strategies relates to the management
coherent to an organization's most valued assets - the people working there who
individually and collectively contribute to the achievement of the objectives of the
business. The goal of human resources management strategy is to help an
organization to meet strategic goal by attracting, and maintaining employees and
also to manage them effectively. In practice, human resources management
incorporates a vast number of issues which include, but not confined to, recruitment,
workforce planning, orientation, skill, training and last, but not the least,
compensation. We have to admit that compensation, amongst other motivating
factors, is the most effective driving force behind a person's desire to perform in the
workplace. There have been many papers written on the most appropriate
compensation scheme. One of the many schools of thought is the performance
related pay which is money paid to someone relating to how well he or she
performs. Car salesmen, real estate agents, production line workers, for example,
may be paid in this way, or through commission. This compensation scheme is
based on the belief that money was the main incentive for increased productivity.
This scheme cannot be applied universally as it has its own limitations although it
has been widely adopted in a number of fields and proven to be successful. The tool
however is a double edged knife and the financial sector has vindicated such a
conviction.
5. One of the causes of the subprime bubble is the pay structure adopted by financial
institutions in launching subprime products. During the subprime cycle, most
financial institutions pursued a compensation scheme which gave incentives to all
personnel involved in the subprime products to chase after high income through
risky trading, launching risky products that generally provided higher rates of return.
Bonus payments for successful and senior investment bankers, including those in
the business holding subprime positions, were very substantial. Essentially, bonuses
were measured against gross revenue after personnel costs, with no formal account
taken of the quality or sustainability of those earnings. We have to admit that greed
is part of our human nature. In the face of profit, quality of product and hence the
revenue derived therefrom could be compromised. The phenomenon was common
among institutions and staff involved in the subprime trade, from top management,
originators, agents to traders.
6. All enterprises, not confined to financial institutions, should learn from this lesson
that, to maintain the sustainable growth of an entity, all compensation schemes
should in future adequately reflect performance in the medium and long term as
well. As a matter of fact, the compensation schemes for staff involved in the
subprime bubble all had a common feature in that there were enormous rewards for
deals but there was also a failure to impose penalty symmetrically when losses
occurred. To put it in a nutshell, a viable compensation scheme should be well
structured and be geared to the long term corporate target and strategy rather than
short term profit.
7. I hope my opening remarks on risk management and compensation management
will kick off a series of discussions on management of other facets of business.
Experts and seasoned practitioners from different trades are going to share with us
their views, experience and insights to resonate with today's theme "Navigating
Complex Challenges through Corporate Strategies". I am sure the conclusions of
this Conference will enable the attendees to formulate the correct corporate
strategies to navigate through uncharted waters of the contemporary global
economy.
Finally, please accept my best wishes for a huge success of this visionary conference.
Thank you.