Posts tagged: internal controls

Do we need new controls, or should we improve the effectiveness of existing ones?

The following article ties in perfectly my research, thus I felt i should share.

WEF urges new controls on financial innovations

Sarah Krouse

27 Apr 2012

Financial innovations, blamed for exacerbating the financial crisis, still face a major perception problem, but a new report says that they should continue to be developed – with better controls.

Photo credit: World Economic Forum, Andy Mettler

Photo credit: World Economic Forum, Andy Mettler

The study, published on Friday by the World Economic Forum and consultancy Oliver Wyman, outlined steps that firms and regulators should take to ensure the responsible development of financial innovations – which include products such as collateralised debt obligations and credit default swaps. The WEF urges stress tests, market trials and changes in incentive structure to stem potential negative outcomes.

At the report’s centre is an outline of the fundamental issue with new products: that they have no track record and therefore no historical data that can be used for reference. The group encouraged testing that acknowledged unknowns and anticipated potential problems.

It also called for more ‘extreme scenario’ stress tests and intervention when products mutate in the markets in potentially dangerous ways.

Banks and other institutions have the responsibility to adjust their enterprise risk management systems to account for risks from new products, educate their boards about new innovations and revise their new product approval processes, the report said.

New approval processes should include market trials similar to those used by the pharmaceutical industry, giving more attention to innovations that come from existing products, and better tracking of products in the market throughout their lives and as they become more widespread.

Regulation should have a lighter touch, allowing for new innovations, the report said, but its authors encouraged collaborations so that both regulators and institutions understand new risks.

To avoid incentivising inappropriate selling of products, as many mortgage brokers were accused of in the boom, the study recommended clawbacks and deferring incentives for products with longer lives, perhaps spreading bonus payments over three to six years

The group also called for an overall “customer orientation” with simple, transparent products appropriately matched to clients’ needs.

By identifying potential negative impacts during the development of new innovations, the groups said they hoped “that the industry will continue to be granted the latitude and enjoy the self-confidence to pursue innovation as a path to individual profit, to industry profit and to wide societal benefits.”


My Thoughts                                                                                                                   Reading this article, I am forced to ponder whether we need new controls, or have to strengthen the effectiveness of existing ones. A review from the literature on structures for governing financial innovation currently suggest that there are quite a lot of controls in place for governing financial activity. Although these do not target regulating the innovation process specifically, it how innovations once they have been commercialized are used. These governance mechanisms are normally regulations enforced externally (by legal sanctions through self-regulatory  and independent governmental organizations) or internally using corporate governance structures. Considering that mechanisms have always existed to govern financial activity, I am of the opinion that there is more of a need for strengthening the effectiveness of controls to govern financial activity. Nevertheless, new controls that monitor the innovation process must be introduced.

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