It seems everywhere I look these days, there’s a conversation about systemic risk.  There are three main ways in which I think records intersect with systemic risk: (1) as an exacerbating factor during times of systemic stress; (2) as a barrier to transparency and accountability post failure and (3) as a means of monitoring levels of systemic risk. 

 We need only look as far as the recent collapse of Lehman Brother’s for a case study of how records both exacerbate other risks under stressed conditions and complicate the work out of risk issues.  Transparency of products was a significant contributor to recent financial turmoil.  Back in 2007, the former Governor of the Bank of Canada, David Dodge observed that increasingly complex structured products were being developed in response to the demand for higher returns. And as these securities became more complex and opaque, in many cases, it became harder to assemble and understand all the information needed to determine what kinds of assets were backing the securities, the quality of those assets, and the counterparty risk involved.  The Governor’s observations predicted the set of circumstances that would contribute to the spectacular collapse of Lehman Brothers in September of 2008, and the reason why so many other banks were affected by the Lehman Brothers’ collapse. 

 At the recent the AKJ Associates’ Electronic Evidence and E-Discovery Forum in London (UK), Jon Hayton, Director of Forensic Technology Solutions at PwC, noted that as part of PwC’s work as the UK administrators for the Lehman Brother’s UK operations his team needed to capture and preserve all data after the collapse.  This process was particularly challenging due to the complex global operations of the firm, but also because of the over 3,000 different IT systems – from spreadsheets, to complex Sybase databases, to bespoke databases – that produced and held the firm’s financial records.  The PwC team has said that Lehman’s faced more risk and cost through poor information management.  This sentiment is echoed in the report on the Lehman’s collapse by the Committee of European Securities Regulators, which notes that maintaining adequate documentation of investments is an essential part of firms’ systems and controls, and is particularly important in stressed conditions.  The report doesn’t mince words on the records issue: bluntly stating that those firms with good records were best placed to assess their exposure to Lehman Brothers as the bank entered administration.

In terms of the third area of the records/risk nexus, the regulatory response to apparent information failures during the global financial crisis is the focus of a recent report on systemic risk out of JWG-IT, a UK financial services think-tank, in the words of PJ DiGiammarino, CEO of JWG-IT, the regulatory response to the global financial crisis has been “to require investment firms to report to the regulators more data from more sources on an ad hoc and periodic basis that must be scrutinised with more care, retained for longer periods of time and shared more widely, possibly being used for additional purposes which have not yet been made clear.”  “This is a very dangerous place to be.” concludes DiGiammarino.  Much as they are often overlooked, records contribute to, and complicate recovery from, market information failures.  If we understand this we are better placed to mitigate risks, whether those risks are internal to a financial institution, or of a systemic nature.

Dr. Victoria Lemieux, Director, CiFER