Wednesday 4 December 2013

Business Model Analysis: the 'C-factor'?

There is fair amount of change happening in financial services regulation in the UK with the creation of new regulators and a new legislative framework.  As Hector Sants warned in 2012, “the changes will not just be structural but involve behavioural shifts from both supervisors and firms.
Amongst all these changes and moves, there seems to be one emerging common factor between the FCA and PRA and between them and the FSA: business model analysis (BMA).  It has a strong overlap with the underlying business strategy.  A BMA has been described as answering six questions:

  1. How does the company create value?
  2. Who does the company create value for?
  3. What is the source of competence?
  4. How does the company competitively position itself?
  5. How does the company make money?
  6. What is the company size ambitions?
A recent speech from Julian Adams, Deputy Head of the PRA and Director of Insurance shows that the supervisor’s interest on BMA is not simply academic: 

“where incumbent firms have suffered competitive pressure in particular business lines, it is not uncommon for such firms to be tempted to increase the level of risk they run to protect their market positions, or ‘diversify’ into other areas in which they may not have the same level of expertise.”

This represents a healthy move away from supervision based on compliance with rules to supervision focused on the business and the underlying risks that arise from the strategy.  The BMA provides then a base line that enables supervisors to understand how trends impact on risk taking or business strategy. 
Given that supervisors have been behind the application of BMA in financial services, BMA remains to a large extent a supervisory tool.  Will it remain so?  Are there potential gains to financial services businesses from undertaking a BMA, even if there is no supervisory visit in the near future? 

I would be interested on your thoughts. 

Wednesday 27 November 2013

The Potential Impact of Solvency 2 Regulation on Competition

One of the challenges about financial regulation is identifying the impacts so that costs can be kept to a minimum and benefits maximised.  Targeting regulation to address identified ‘market failures’ helps but it also require an analysis of the costs and benefits.  

Some impacts can easily be measured, like the cost of changes to IT systems.  Others are not so easily measured like the impact on how firms compete in the market place.  For example, regulation can create barriers to entry that can undermine the efficiency of competition. 

The potentially negative impact on competition because of market consolidation was one of the concerns at the time of the publication of the Solvency 2 directive.  There were two aspects to this concern:

(i) reducing capital requirements by taking into account the pooling of un-correlated risks could benefit disproportionally large and well-diversified insurers.

(ii) the fixed costs of risk management and compliance aspects of Solvency 2 could bear more heavily on small and medium insurers.

Relevant extracts from the Commission’s impact assessment of the Solvency 2 directive published in 2007 are below:

"The recognition of diversification effects implies that well diversified entities, or those which are part of an insurance group will, in practice have lower capital requirements than single solo entities which are less well diversified. Although this is fully in line with the basic economic principles underpinning the proposal, and does not entail lower protection for policyholders, it may nevertheless act as a catalyst to the already existing trend of consolidation in the EU insurance market and increase already existing competitive pressures on small and medium-sized insurers. This however does not mean that small and medium sized insurers would be expected to quit the market in a disorderly way following the introduction of Solvency II, but rather that they would be incentivised to look for new partnerships and alliances. Moreover, many small and medium sized insurers are specialised insurers that carefully monitor and manage their risks, and benefit greatly from being close to their customers. Where this is the case, these natural competitive advantages will be fully recognised and will result in lower capital requirements for those companies." (Commission’s Impact Analysis of the Solvency 2 directive, page 49)

"Insurers may also have incentives to consolidate further, as the implementation of Solvency II could require substantial investment in data collection, IT and risk management systems and expertise. Similarly, strengthening risk management will give rise to fixed compliance costs which are likely to fall more heavily on small firms. While this effect should be smoothed by applying the roportionality principle (limited reporting requirements for small firms), the higher weight of compliance costs for small firms could be a further driver of consolidation.  Moreover, the use of relatively sophisticated internal models for risk management could ensure lower regulatory capital requirements - and a consequent pricing advantage – for bigger insurers."  
(DG ECFIN Report - Section 3.4.1)

As noted in the assessment, an important point to bear in mind is that the underlying effects mentioned above exist anyway.  So the question is really about the extent to which Solvency 2 exacerbates these trends significantly.

A few years have now gone through and I would be keen to hear your thoughts about a number of aspects of the impact of Solvency 2 on competition:
  • You may have observed negative effects on competition in the product space as a result of Solvency 2.  If so, could you share details about your observations?
  • If you have not observed a negative effect on competition, do you believe that it’s just a matter of time until we do?  For example, you could take the view that the reason we have not observed a negative impact is that Solvency 2 has not yet been implemented.  
  • You may take the view that the absence of negative effects on competition is the result of changes in the industry landscape.  For example, a recent CSFI survey ‘Insurance Banana Skins 2013’ suggests that there is a significant amount of capital in the insurance industry (‘capital availability’ goes from the second highest concern in 2012 to number 16 in the 2013 survey).  If so, do you believe that the increased availability of capital has muted the potential impact on competition?  Are there any other relevant changes in the industry landscape that have a similar effect? 
  • Finally, you may take the view that we are unlikely to see a negative effect on competition.  This could be because regulation’s marginal impact on existing trends is unlikely to be material.
I would be grateful for your thoughts.  If you want to share your thoughts privately, email me at isaacalfonblog "at"  

This is not intended to be a scientific poll but if there are sufficient answers I will summarise the emerging views (without attribution) in a future post. 

Thursday 21 November 2013

Conduct risk: old wine in a new bottle?

The establishment of the Financial Conduct Authority (FCA) as the new conduct of business regulator in the UK has brought a new focus to 'conduct risk'.  I have been working with BaxterBruce, a management consultancy, on this issue.  We have written a paper (here) summarising the recent changes in financial regulation that are relevant to conduct risk and identifying what steps businesses may consider to meet this challenge.  

There is also an emerging international dimension to conduct risk that I will cover in a future post.

Monday 18 November 2013

Banking regulation: a new paradigm, more challenges but similar consequences

The Bank of England recently published a discussion paper (here) setting out a comprehensive framework for coordinated stress and scenario tests of the UK banking industry.  

This process is challenging but necessary to underpin the resilience of the UK financial system.  As set out in the paper, other countries are going through similar exercises and there is a view that they can be instrumental to restore the credibility of the banking system.  

In 2014 the exercise will cover the eight banks covered in the recent regulatory capital shortfall exercise (Barclays, Co-op Bank, HSBC, Lloyds Banking Group, Nationwide, Royal Bank of Scotland, Santander UK and Standard Chartered).  For future years the Bank is considering the inclusion of medium-sized banks.  It is also likely to include UK subsidiaries of foreign globally systemic banks. 

At a high-level, the approach is reasonably straightforward.  Staff at the Bank design common stress scenarios for all banks which look into the next three to five years.  The severity of the scenarios is described in qualitative terms – “both sufficiently severe but also plausible”. 

Each bank goes through a similar process and creates specific stress scenarios.  These must be consistent with the bank’s business model and key vulnerabilities and be as severe as the common scenario.  

Then a bank assesses the impact of both types of stress scenarios and considers the management actions that may be needed to ensure that the bank can meet the capital requirements prescribed by the PRA (or at least the internationally agreed minimum capital requirements) after the stress.

Towards the formalisation of a new paradigm …

It seems that there are two major changes to banking regulation in this process. 

Firstly, going forward it would not be enough for a bank to just meet its capital requirements.    A bank should demonstrate that it would meet its capital requirements after a stress has taken place.  This could have implications on a bank’s capitalisation level.

The next change is about reducing the reliance on a bank’s internal models.  Officials at the Bank have raised these concerns before, for example, in this speech of Andrew Haldane (here).  In particular, the evidence about the large number of parameters that need to be calibrated is sobering.  The paper sets out the Bank’s intention to rely on a suite of models to assess capital adequacy, including a bank’s internal models, regulatory models and models of the entire financial system that build in the impact of interaction between institutions. This is consistent with the doubts that have been expressed.  You could say that the message is that a bank’s internal models would be credible if it is operated in a context where the bank has sufficient capital to meet its capital requirements after stress scenarios.

… which creates challenges for the Bank …

I suppose that for a regulator like the Bank defining “sufficiently severe but also plausible” stress scenarios is not perhaps the most significant challenge.  My guess is that the real challenge would be in terms of applying judgements to the results provided by banks and consolidating the impact across a number of scenarios for each bank and for the system as a whole.  One would hope that there will be enough transparency so that a bank’s executives understand where and how their conclusions may differ from those derived by the Bank.  

The other challenge would be the inclusion of medium-sized banks.  The paper is open about the challenge that this may represent for these banks.  The Bank would need to balance that against the recognition that medium-sized banks like Northern Rock can also create systemic disruption and put taxpayers’ money at risk (here).  One possible way of reducing the impact would be to integrate this exercise within the existing ICAAP and Pillar 3 disclosures frameworks.

… and for banks

UK banks have been undertaking stress and scenario tests for regulatory purposes.  The paper includes a list of the shortcomings that the FSA had identified: 
  • “insufficient engagement by banks’ Boards and senior management with the stress-testing process;  
  • insufficient integration of stress testing with banks’ annual business planning process, including the use of stress tests as a challenge to business plans; 
  • inadequacies in scenario design, including the failure to identify key vulnerabilities, overly optimistic baseline assumptions and insufficiently stressful adverse scenarios;
  • difficulties in reconciling risk data with reported balance sheets and risk-weighted assets;
  • stress-testing infrastructures that have not been suitable for bank-wide stress testing;
  • insufficiently justified or internally challenged assumptions and judgements around the translation of macroeconomic shocks into projected losses, including overestimation of banks’ ability to control margins and generate profits in stress scenarios; and
  • inadequate determination and quantification of relevant management actions under different stress scenarios.”
The paper does not say much about how generalised these shortcoming are.  However, I found it very interesting that most, if not all, of those shortcomings are related to weaknesses in processes and governance rather than technical issues. 

There are also consequences …

And in case those reading the paper have doubts about the Bank’s determination to see this through, the Bank suggests that failure to address these shortcomings will result in regulatory intervention. 

“The exercise might reveal weaknesses in banks’ stress-testing and capital planning processes and governance. In those circumstances the PRA would consider what action was appropriate to ensure that shortcomings were addressed. The PRA has a variety of formal powers available. Additional capital requirements might be one tool. Withdrawing certain permissions, changing banks’ management and requiring specific actions to improve banks’ stress testing, risk management or capital planning processes are others.”

Summing up, we may be witnessing the formalisation of a new paradigm for banking regulation that places less reliance on a bank’s internal models but the potential enforcement side does not seem to be changing.  

The paper includes a number of specific questions and responses are requested by 10 January 2014. 

Wednesday 13 November 2013

The Fate of Solvency 2 ...

There was today a Solvency 2 trilogue between the European Commission, the Council and the European Parliament.  Gideon at articulates very well what are the open issues (here).  Who knows tomorrow we may know the fate of Solvency 2.

Tuesday 12 November 2013

Re-stating the Case for Solvency 2

In the midst of following press-reports about the tri-logue discussions about Solvency 2 and given the passing of time, I had almost forgotten what it is all about. 

I am starting to give some thought to a training course that I will be delivering in March 2014 for Euromoney (here).  As a result, I have been dusting off documents like the Sharma report from 2002 (here).

This provided a useful reminder of what it is all about:

1.  Common approaches for supervision.  

The underlying differences that challenge an agreement on Solvency 2 between the Commission, Council and Parliament: the extent of different supervisory objectives and approaches that exist(ed) are quite significant.   

The differences in the table put the progress to date in terms of legislation in perspective.(*)   This is also a useful reminder of why Solvency 2 is a European project.  You may disagree that Solvency 2 should be a European project but that's a different point. 

2.  The important role of risk management and senior management 

In the words of the report ...

"Although a well-managed firm can still fail, poor management makes a firm vulnerable and we believe that in practice it is the primary root cause of most problems in insurance firms.  We found that poor management can take one or more of the following forms:

(i) management are competent but have an excessive risk appetite or a lack of integrity or independence; or 

(ii) they operate outside their field or level of competence;
(iii) they fail to put in place adequate decision-making processes or adequate internal controls."

So perhaps there will be an agreement in the trilogue.  Then there will be a lot of detail - delegated acts, implementing technical standards - to discuss and assimilate.  However, I hope these messages about the case of Solvency 2 do not get lost ... 

(*)  I am assuming that there haven’t been drastic changes across the EU in terms of supervisory objectives in the run-up to Solvency 2 and notwithstanding EIOPA’s work to bring about supervisory convergence, which will continue past any agreements at the trilogue.  

Monday 11 November 2013

Freakonomics and Insurance Regulation

A post from the Freakonomics blog (here) highlights an interesting paper (here) about insurance regulation by Ralph Koijen and Motohiro Yogo.  The paper looks into the growth in the use of ‘shadow reinsurance’.  Freakonomics is concerned that there may be a bubble building up. 

I believe the underlying issue represents a good example of the law of unintended consequences that applies sometimes to financial regulation. This post will explain that and offer some thoughts from a Solvency 2 perspective.  

Some context – shadow reinsurance

There isn’t a formal definition of shadow reinsurance. Koijen and Yogo refer to shadow reinsurers as “affiliated and unauthorised reinsurers without an A.M. Best rating” in the US or offshore. (The paper used A.M. Best data, hence the reference to them in the definition.) 

The use of shadow reinsurance has also been covered in a recent report (here) from the NY State Department of Financial Services (DFS).  The DFS has a similar definition in mind, other than the ratings consideration.

Unintended consequences

The likely chain of events leading to an increased use of shadow reinsurance is set out below.   

Firstly, supervisors introduce new reserving requirements for certain term and life insurance products, so called XXX and AXXX reserving requirements respectively. 

These new reserving requirements require the use of stringent assumptions, which have been described as resulting in reserves “over eight to 10 times that of an ‘economic’ type reserve, such as a FAS 60 reserve under U.S. GAAP” (here).  I don’t really know if this estimate has passed the test of time – the paper is from 2005 – and the quote is offered as an indication of the conservativeness of the underlying assumptions.  As a footnote, it is worth noting that industry papers tend to refer to the delta between economic and AXXX / XXX reserves as ‘redundant reserves’.

Secondly, firms take action to reduce the impact of non-economic regulation. 

This requires an understanding of the prevailing regulatory environment.  Insurance companies would then realize that they can reduce the impact of these stringent reserve requirements by transferring some of these liabilities to special purpose vehicles (SPVs) in such a way that an insurance licence is not required. There are then some additional issues which give rise to the need of letter of credit to the originator. However, the key point is that if the recipient of the liability is not an insurance, the stringent valuation requirements would not apply.  

So far so good from a company's perspective.  However, what appears surprising is that state supervisors have a role in approving these transactions. There is even a sub-group of the NAIC Executive Committee called “Captive & SPV use sub-group” (see last page of this report).  It is therefore not entirely surprising that one of the DFS report recommendations is that state insurance commissioners stop approving these transactions:

“state insurance commissioners should consider an immediate national moratorium on approving additional shadow insurance transactions until […] investigations [by the Federal Insurance Office, Office of Financial Research, the NAIC and other state insurance commissioners] are complete and a fuller picture emerges.”

It would appear that the same supervisor that introduced stringent reserving requirements has a role in approving transactions aimed at reducing the impact.  This begs the question of what is the value of these onerous reserving requirements. 

Back to economic rationality, it is not entirely surprisingly, that the data in the paper also show that the (mean) reinsurance shifted to shadow reinsurers increased during the financial crisis when the uncertainty about valuations probably increased (Table 2 of the paper).

What about Solvency 2?

The essence of the unintended consequences means that it is difficult to foresee if similar transactions would happen under Solvency 2. 

The key point is that there would less incentive for these transactions to take place because it would not appear that the Solvency 2 reserving requirements would be uneconomical as in the case of AXXX and XXX requirements.  Although depending on the on-going discussion about the treatment of long-term guaranteed products, it may be argued that for certain insurances the Solvency 2 reserves are uneconomical. 

However, there are two additional considerations that would make the outcome in the paper less likely under Solvency 2. 

Firstly, there are specific articles in the directive about SPVs used for reinsurance purposes which require authorisation and the application of solvency requirements.  This would mean that shifting liabilities to SPVs would not necessarily mean a reduction in reserving and capital requirements.  (If you want to see the detail of the likely implementing measures, please check EIOPA’s advice to the Commission - here).  

Secondly, within the Solvency 2 directive a group is widely defined.  Personally, I would be surprised to hear that this could be read to exclude such SPVs.  More generally, the default approach to calculate the group solvency requirements is based on the consolidation of all exposures, which would mean that the effect of the transfer to an SPV cancels out.
The Solvency 2 implementing measures will  provide additional details about these issues but, as ever, regulation can have unintended consequences in particular when there are uneconomic requirements.

Friday 8 November 2013

Pragmatic Implementation of ERM in Financial Services - the Internal Audit Perspective

I wrote in a previous post (here) about a pragmatic approach to implement ERM in financial services.
This was partly about recognising the practical implications of what is often said that ERM is a journey rather than a destination.  The suggestions made included assessing regularly the effectiveness of the ERM system to inform future improvements and that internal audit teams be tasked with that assessment, given their independence from the business and risk function. 
Someone suggested that I look up the report of a commission established by the UK's Chartered Institute of Internal Auditors to consider the effectiveness of internal audit in financial services (here).
I was pleasantly surprised to read one of the recommendations:  Internal Audit should include within its scope an assessment of the adequacy and effectiveness of the Risk Management …” (page 8 of the report).
It is interesting that while the Chartered Institute of Internal Auditors and I were looking at this from different perspectives – assurance and implementation, respectively – we both ended up with the same conclusion about the importance of assessing how ERM is operating in practice. 
Leaving this aside, the report is worth reading to see in practice how risk considerations are affecting other parts of a financial services business.  Wearing my economics hat, I particularly liked the Committee’s recognition that mandating 'best practice' of application would not be appropriate (page 5).  Indeed, there is a cost-benefit consideration for each financial services business which should shape how these guidelines are complied.  Requiring best practice simply rules out this cost-benefit consideration, which can be more beneficial in the long-term.   

Tuesday 5 November 2013

Financial Regulation: (first) Overview of 2013

An interesting overview of 2013 from the perspective of financial regulation with a banking / trading flavour is here.  For me, the top two highlights were that:

  • regulatory fines were getting bigger and their target smaller;
  • regulators started to get serious about data.

I'd be interested to hear what are your top two for 2013 from that list or your own.

Monday 4 November 2013

A 30-second Elevator Pitch on Enterprise Risk Management (ERM) in Financial Services

For some time, I have been thinking about a 30-second elevators pitch on ERM as I have seen it applied in financial services.  I have had in mind something based around the risk and return trade-off in investments; something that says decisions need to take account of risk and returns - and not just returns.  While this makes sense to me on a conceptual level, I don't think it gives a sufficiently accurate description of the many activities associated with ERM.

I think I have found something that works better for me: 'protect and enable'.  I think it captures well the tension between risk and return.  It also seems to highlight the business challenge of risk and compliance functions in terms of designing and operating controls and reporting mechanisms and the wider involvement of risk in decision making.

Sadly, I did not come up with this way of summing up ERM.  I read this in the transcript of a UK bank appearance in front of a UK Parliament Commission on Banking Standard - worth a reading in its own right. (Click here to read the transcript, 'enable and protect' features in the response to DQ462.)

I would be interested to know if you have come across 'protect and enable' before; a quick search in Google did not reveal much.   Does 'protect and enable' work for you?  Are there any alternatives that work for you that you can share?

Friday 1 November 2013

A Pragmatic Approach to Deliver Enterprise Risk Management (ERM)

Banks and insurers spend large amounts of money on risk management.  Increasingly this expenditure tends to be part of an ERM programme where a holistic and enterprise-wide view is adopted.  This involves delivering appropriate tools and changing the business culture.

There are many challenges to deliver successfully an ERM programme.  It is usually accepted that one of them is embedding ERM.  However, the changing nature of financial services means that the main challenge to deliver an ERM system would be managing a process of continuous improvements and getting ERM to work over a period of time rather than at a point in time.  This has a number of implications for how financial institutions should regard ERM programmes.  

An immediate implication is that delivering an ERM system would be less of a ‘big-bang’ where this vision is adopted from the outset.  First steps would likely be material to signal the enterprise-wide dimension and start changing the culture.  However, an important part of the cultural change would be about explicitly recognising that it is a process of continuous improvements.  This should also bring about a focus on easy-wins, which is usually regarded as contributing to the success of transformation processes. 

Where an ERM programme has been going on for some time, this alternative approach would require a different vision and a change in the ‘tone from the top’.  This would mean a change in the risk culture of the business.  Given that the vision is more pragmatic and consistent with the changing nature of financial services, I would not envisage a significant challenge from modifying the culture. 

In my view, the real challenge arising from an ERM perspective of continuous improvements is identifying what are those changes that should happen over time.  This requires initially identifying the minimum that must be implemented to meet the expectations of various stakeholders.  This approach also requires identifying and monitoring the maturity of the ERM system in a structured manner at regular intervals.  That goes beyond taking stock of what has been implemented and should cover the effectiveness of the tools and processes that have been put in place.  Gaps will not necessarily reflect shortcomings in the implementation but changes in the business and in the markets. 

There are already tools available to assess the maturity of an ERM system, which would provide useful starting points.  For example, the International Actuarial Association published an ERM assessment tool that covers 14 categories ranging from board engagement to risk management culture and rates an insurer’s position as ‘early’, ‘intermediate’ or ‘advanced’.  Internal audit functions would be well placed to lead these assessments given their independence from business and risk function.  

Understanding the maturity of your ERM system is fundamental to ensure that there can be an adequate assessment of the costs and benefits of alternative improvements so that these can be prioritised accordingly.  This perspective means that one of the key documents for senior management of an ERM programme would be robust road-maps that set out prioritised improvements.  

Overall, a perspective of continuous improvements means that the process to deliver an ERM system becomes as important as the objective.  This is more likely to result in genuine embedding. 

Wednesday 30 October 2013

Negotiating - Practical Lessons from the Creation of the IMF

If you work in risk management or economics, there is a reasonable chance that you juggle between the 'important' and the 'urgent' and that you interact a great deal with colleagues, counterparts and peers.

I recently reviewed the book 'The Battle of Bretton Woods: John Maynard Keynes, Harry Dexter White and the Making of a New World Order' by Benn Steil for the journal 'Central Banking'. 

The context of the book is the economic negotiations between the US and the UK in the lead up to the Bretton Woods conference and the establishment of the IMF.  From the perspective of Keynes and the UK, it provides a fascinating account of how the 'important' prevailed over the 'urgent' and how not to negotiate. But the book is more than just that it becomes at times nearly a thriller.  Harry Dexter White was Keynes' US counterpart and it turns out he was also spying for the USSR.

If you are interested you can read my review here or below.

Book notes: The Battle of Bretton Woods: John Maynard Keynes, Harry Dexter White and the Making of a New World Order
A fascinating account of the Bretton Woods conference from the point of view of its two main players: John Maynard Keynes and Harry Dexter White
Author: Isaac Alfon
Source: Central Banking Journal | 12 Aug 2013
Categories: Governance
Topics: Bretton Woods

Benn Steil, The Battle of Bretton Woods: John Maynard Keynes, Harry Dexter White and the Making of a New World Order, Princeton University Press, 2013, 472 pages

Benn Steil’s book provides a fascinating account of the developments leading up to the Bretton Woods conference and its immediate aftermath, from the point of view of the two main characters involved: John Maynard Keynes and Harry Dexter White. The book is based on extensive archive work, so often the participants speak for themselves, which makes for interesting reading.

It is striking that the US Secretary of the Treasury, Henry Morgenthau, instructed White in December 1941 to “provide the basis for post-war international monetary arrangements” when victory in the Second World War was still not even in sight, even if the underlying intention was to shift the centre of world finance from London to Wall Street. If that foresight about the next steps had become the norm, perhaps today’s geopolitical landscape would also look different.

The book evidences the challenge of being the ideal economist: in Keynes’ own words, “a mathematician, historian, statesman and diplomat”. Despite his academic achievements, Keynes’ record as an economic diplomat is poor and he was described by other UK officials as a “menace to international relations” and “too offensive for words”. Modern central bankers are likely to share with Keynes an involvement in international negotiations. Keynes’ track record provides a few ideas of how or how not to conduct them.

First, understand your principal strategic priorities. One of the main challenges is identifying what is important and what is urgent for your organisation and prioritising accordingly. At that time, the important issue for everyone (not just the UK) was a new system of exchange rates that brought stability, avoided competitive devaluations prevailing before the Second World War and supported international trade. The urgent issue for the UK was indebtedness and the need for short-term finance at a reasonable cost with no political conditions. Keynes’ focus on the important is certainly appropriate. However, as documented in the book, a solution to Britain’s urgent issue, indebtedness, could have been available from US bankers and others and it is surprising Keynes stopped a consideration of this ‘alternative’. As Steil tells us, British prime minister Winston Churchill’s objective for the war was to survive it: the urgent. Not surprising then that, as Steil also notes, there is only one reference to Keynes in Churchill’s five-volume history of the war.

Second, while understanding the logic of your position is a must, fully sharing that with your counterparts may not be in your interest as it may reveal a weakness. One example is Keynes’ clear articulation to the Americans of the necessity of post-war British trade discrimination.

Third, understand your counterparty’s perspective and vision. Steil is clear from his research that the US administration saw the UK as a rival for economic and political power. However, there does not seem to be recognition in the British sources quoted that this might be driving the US negotiating positions. In fact, the opposite may be true: Keynes associates the behaviour of Americans to a supposed lack of understanding that, for example, the lend-lease arrangements put in place to finance the war would have devastating effects on Britain after the war.

Fourth, look after your counterparty. It is easy to make this personal but this is a wider point. Steil notes that “Keynes’s lack of humility appears to have prodded [US president Franklin] Theodore Roosevelt’s advisers to tighten their demands, lest they be caught out by clever arguments down the road”. And fifth, provide accurate progress reports, in particular when your position is weak from the beginning. Steil identifies, for example, the contrast between the gap in the US and UK positions in the lead-up to Bretton Woods and Keynes’ progress reports.

White is unlikely to be as familiar as Keynes, unless one has an interest in spying and the Cold War. White’s progression to the US Treasury is far from straightforward and for most of his time at the Treasury he was a temporary civil servant. The Treasury seemed his natural home given his “mind for economic policy” and “flair for converting economic theory into administrative practice”. Steil sees him as an “idealist who envisioned a future in which world affairs were managed by enlightened technocrats”. It might not be unreasonable to guess that his admiration for the Soviet revolution led to “freelance diplomacy” and evolved over time into spying for the Soviets.

In terms of economics, both White and Keynes share the overall objective of monetary and currency stability. The important differences lie in the role of gold and the US dollar, and the governance of the International Monetary Fund (IMF). The latter reflected the different positions of the UK (a debtor) and the US (a creditor). Not surprisingly, Keynes wanted less power for the IMF and more discretion to member countries and White pushed in the opposite direction. White also turns out to be a skilful tactician who developed a team and carefully orchestrated the negotiations leading up to the conference and at the conference, to successfully enshrine the US dollar as the reserve currency in a system of fixed exchange rates.

Steil highlights how the views of the US and UK on related issues have changed over time: pegging currencies to the US dollar (US, against then), sharing the cost of adjustments as a result of trade imbalances (US, against then), the necessity of preferential trade treatment (Britain, in favour then). This is a very practical reminder of what Greg Mankiw has described as the difference between economics as a science and an engineering/problem-solving discipline. 

The book ends with a chapter where Steil seeks to draw conclusions for today’s market conditions. He brings in Milton Freedman’s views in favour of floating exchange rates and, overall, I have sympathy with the argument that governments should focus on wealth creation, rather than endless negotiations. It is difficult to challenge Steil’s doubts that another “grand design” would fail to solve the current trade imbalances unless the US and China agree about the need for action. 

Welcome to My Blog

I am pleased that you are reading this.  After some thinking and discussions with some people, I have decided to start this blog to share thoughts on what I know - or don't know.  Seriously, I intend to write about what is at a crossroads between enterprise risk management (ERM), financial regulation and economic analysis.

And the name?  Well, my wife came up with the name 'crescendo' for her art business and she has kindly allowed me to use her idea of a name.  If you speak Italian or learnt music - none of which apply to me - you know that crescendo is something that increases in strength.

I hope you enjoy the postings and that they increase our mutual understanding.  Please get in touch with any thoughts and observations.  I would like this to become a two-way conversation.