Asset Securitization and Financial Risks

Metropolitans such as New York, London or Hong Kong may have been established as international finance centers and their financial system may be so sophisticated that an array of risk management measures have long been in place, sometimes things will still got out of hand. The financial tsunami in 2008 taught us a valuable lesson. Mr. Desmond Cheng, Senior Vice President of Hong Kong Mortgage Co. Ltd. Was invited to speak in a professional seminar organized by HKU SPACE College of Business and Finance on 27 October 2010, in which he delivered an informative and insightful speech on risk management and asset securitization.

The Big Picture in a Simple Principle

Desmond gave a detailed comparison on the intricate relationship between banks and insurance companies in his 90 minutes talk. In revealing the fact that financial institutions face new challenges arising from the rapid growth of derivatives, the decomposition and distribution of credit risk through asset securitization, the combination of mathematical models and computing power in risk management, “shadow" banking network of investment banks and new regulatory framework, Desmond presented the big picture of the finance sector. Finance professionals are certainly inspired. And it is noteworthy that a portion of participants are working in non-financial positions, as an indication of heightened awareness upon financial risks.

Dr. Dominic Li, Consultant and Associate Head, College of Business Finance, HKU SPACE got us prepped before Desmond’s speech with his explanation and analogy of the concept of normal distribution. He said, "Same as the remote chance of getting the same number on all dices in a throw, normal (or gaussian) distribution is telling us random variables tend to cluster around a single mean value. The financial risk management system was basically operated under that principle. But there are, however, chances for the unlikely to happen. The Postgraduate Diploma in Financial Risk Management course offered by HKU SPACE aimed to provide students with not only theories, but also an understanding of the impact of human factors in the 21st Century economy through case studies."

Key Questions for Risk Managers

Desmond then highlighted the differences in implementing risk management measures between banks and insurance companies and their risk management agenda in the post-crisis period. He also pointed out that securitization was adopted by the finance sector to ensure the liquidity of their assets. "Each and every part of our finance system is in fact interlinked in a complex relationship. The banks' network has been functioning as a major sales channel for the insurance industry since 20 years ago. As time goes by, the extensive network became a competitive edge and finally dominated the market." Desmond said. Nevertheless, banks nowadays are still selling products offered by insurance companies and a mutually dependent relationship is formed.

Managing risk in this kind of environment is never easy. That is why Desmond stressed that risk managers should make sure they have an affirmative answer to the following key questions:
1) As a risk manager, how well you understand the way your organization operates? i.e. the business model, income source and key risk drivers.
2) How well you understand the position and relationship with other players in the eco-system?
3) Did you get buried in the details and not seeing the big picture?

What and Why instead of How

The last question raised a few other considerations which are noteworthy for prospective students and practitioners in the finance industry. Desmond said, “Risk managers should find a solution for the business as a whole, instead of just solving their own problems."  In a word, he reminded us to focus on "What and Why" instead of "How."

Securitization may have been one of the contributing factors in the 2008 crisis, but Desmond stated that the securitization process has its value and function to maintain asset liquidity. It is the moral hazard and human errors that deserve our attention and regulation. Echoing the opening address by Dr. Dominic Li, financial risk management is a subject associated with corporate finance, accounting, business operations and corporate governance. If you are reading this article, you may have already been looking far ahead through continual learning and upgrading. But certainly it is also important to have a wider scope of view on your path to be a successful finance professional.

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