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An often-misunderstood category of finance worker, which already was showing a rising profile, may now be in line for a quantum leap.
Robert Hertzberg, CFO.com | US
September 15, 2008
The downward slide of Lehman Brothers and Merrill Lynch, culminating in this weekend's stunning announcements, seems like more evidence of the poor quality of risk management on Wall Street — alongside Bear Stearns' failure, the $7 billion loss caused by a rogue trader at Société Générale, and the loading up on mortgage-backed securities by virtually every major U.S. bank.
But in fact the troubles of Lehman, which faces liquidation, and Merrill, which agreed to be bought by Bank of America, may amount to a full-employment act for financial risk managers, a category of worker that may not have caused the most recent Wall Street meltdown, but that will likely be called on to help avert the next one.
"It's an exploding category," says Mitch Feldman, president of A.E. Feldman Associates, a recruiting firm with offices in Manhattan and Great Neck, New York. That's not just because of turmoil in the financial markets; it was hot even before the credit crunch began more than a year ago, Feldman adds.
For all of the attention being paid to it, however, financial risk management is a widely misunderstood area. It is not about eliminating or minimizing risk, as its name might imply. Instead, it is about avoiding uncompensated risk. As Aaron Brown, a risk manager at hedge fund AQR Capital puts it, "You can't be a good risk manager if you don't love risk."
The term is squishy enough so that no one knows for sure exactly how many people work as financial risk managers. One measure of the growth, however, is the increasing number of registrants for an FRM certificate, which allows financial professionals to demonstrate proficiency in areas like value at risk and the Basel accord, an international standard for banks that is driving a lot of regulatory change.
More than 13,000 people have registered for this November's FRM exam, a number that beats last year's record level by 36%, according to the Global Association of Risk Professionals, the organization that administers it.
Tens of thousands of people in the commercial and investment banking sector do some form of risk management, regardless whether the word "risk" is in their titles. Most traders and portfolio managers are in effect risk managers, says Brown, who has a degree in applied mathematics from Harvard and has also worked at Citigroup and Morgan Stanley and been a finance professor at Yeshiva University in New York.
In fact, it's the risk managers who are in revenue-generating positions who tend to be a financial firm's most sophisticated dealers in risk. Brown gave the example of a No. 2 trader on an investment bank's fixed-income desk, who might be getting a bonus of $10 million in a good year.
Indeed, financial risk management can be a lucrative field. Recruiter Feldman says the director of collateral risk management at a bank might earn a salary and bonus equal to $500,000 — and report to someone making twice that. A promising entry-level recruit joining a bank or hedge fund in a risk management position might get a guaranteed first-year package (salary plus bonus) of between $200,000 and $250,000, Brown says.
At the lower end of the spectrum are people doing things like risk reporting and credit reporting. These are back-office jobs for which meticulous accuracy, not trading skill, is the chief requirement; the positions pay far less and are rarely glamorous.
Peter Chromiak learned about back-office risk management work during the almost two years he toiled for a firm that trades energy futures. Chromiak's job was to keep track of the positions of one of the firm's top traders, and forward that information nightly to the risk manager. The risk manager would look at the open positions held by the trader, who was uncharacteristically making a lot of losing trades, and would inform the trader of positions he needed to liquidate.
"It was a constant tightening of the leash and loosening of the leash, depending on the number that was coming in," says Chromiak, 24, who is now enrolled at the Haas School of Business at Berkeley and is pursuing a master's degree in financial engineering. Chromiak didn't like the work, feeling he had no control and that the trader whom he was responsible for monitoring didn't respect him.
Such disillusionment is common, especially with new employees trying to make their mark in the risk management field. "If you're standing there with a trader who's making $100 million decisions every day," Brown says, "and the biggest risk decision you've ever made is whether to buy a one-day metro card or a one-month metro card, and you say, 'Gee, my model says you should cut all your positions to zero,' he's not even going to hear you. He's in a different place."
Some of the most important risk management work happens in what Brown calls the middle office. This is a group of senior managers and technical experts — typically physicists and other "math geniuses" skilled at complex modeling, Brown says — whose job is to look at risk on an enterprise level.
A bond trader in New York, for instance, may not know that his firm already has a big exposure to Russian bonds via the fixed-income desk in London. Or a foreign exchange trader may not realize that by going long the dollar he is doubling up on a bet his colleagues in Hong Kong have already made against the Renminbi.
It's the job of the middle office, which is generally overseen by a chief risk officer, to identify these lopsided risk positions and get the business units to unwind them. The reporting line is usually through the CFO, so being "the world's best quant," as one insurance executive puts it, isn't enough.
"The challenge is to find somebody who can pry into the mechanics of a very complex simulation engine and also distill elements of that in a very succinct manner and communicate it to very senior management and the board," says Michael Mahaffey, vice president of enterprise risk management at Nationwide Insurance in Columbus, Ohio. "If you have a blend of those two things, you're golden."
Mahaffey teaches a class in risk management at the Fisher College of Business at Ohio State University, and he says that for a young person interested in entering the field, a multi-line insurance company like Nationwide offers the broadest exposure to risk.
Regardless whether that is true, financial risk management is certainly moving beyond Wall Street. Richard Dowd of Dowd Associates Executive Search in White Plains, New York, says the treasury departments of some big consumer companies are now looking for managers to help them manage interest rate and currency risk. The corporations are especially interested in people with technical undergraduate degrees and MBAs in finance, usually from top-20 schools. Strong candidates can command base salaries starting at $150,000 to $200,000 plus bonuses, Dowd says.
Rajat Gupta is one of the financial risk managers Dowd recruited. Gupta, who was trained as an electrical engineer in India and has an MBA from the Thunderbird School in Arizona, has worked in treasury management for about 16 years, the last three at Bunge Ltd., the agriculture and food giant. He says non-financial companies often encounter risks that "come embedded in the business."
These can be anything from balance-sheet assets of a foreign unit that must be translated back into the home currency, to the much more complicated situation where a company has supply-chain partners operating in multiple geographic regions, and doing business in different currencies.
"That could create a very substantial exposure, and potentially move margins by several hundred basis points," says Gupta.
"In some ways," he says, "it's much more of a challenge than doing the same thing at a financial firm."