Second-order derivative

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A warning light does not solve a human error problem, it creates new ones. What is this light for? How do we respond to it? What do we need to do to make it go away? It lit up yesterday and meant nothing. Why listen to it today?

—Sidney Dekker,The Field Guide to Human Error Investigations

In which the JC has made up some risk-management jargon, inexpertly cribbing from actual terms used in actual calculus, about which the JC knows 0. So, apologies in advance, but don’t be upset if I’ve made a balls-up of this.

In risk management, the first-order derivative of an event “ƒ” is the effect that event would have, were it to actually happen in the practical world.

So, for example, the counterparty has failed to make a payment.

The second-order derivative, of function ƒ is a derivative of the first-order derivative of that function. So, for example, the warning light on a control panel, the RAG status indicator on a management PowerPoint, or the numerical quantity of an item (completed ISDA negotiations); reviewed legal netting opinions) whose quality one doesn’t have the subject matter expertise to assess.

Operations people deal with actual risks; legal eagles and fellow controller subject matter experts deal with first-order derivatives of those actual risks — what the consequences are if the risk comes about — and middle management and internal audit deal with second-order derivatives, being derivatives of those first-order derivatives of the underlying risk: what the RAG status on the opco dashboard should look like if a NAV trigger is hit; whether the template confidentiality agreement as been reviewed within the six-month time limit arbitrarily prescribed by some policy for the review of standard form legal agreements — that kind of thing.