Coping strategy

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A means of dealing with a risk, situation or unwanted outcome. These fall into a few categories:

  • Risk management: Practical things you can do each day to minimise the probability of unwanted events which could be catastrophic, coming close to happening in the first place: Hire experts. Don’t do risky stuff. Avoid concave risks. Monitor your clients. Be watchful.
  • Limits: Mines, defences and bear-traps you can set to scare off bad things if they do come to close: Margin, security, risk limits
  • Enforcement: Airbags, roll-bars, inflatable life-rafts and avalanche kits that kick in once bad things have happened: Close-out rights, events of default, indemnities.
  • Exoneration: means by which you, personally, avoid being blamed for things that did happen and were catastrophic. Disclaimers, disclosures, weasel wording.

The running cost of exercising coping strategies is inversely proportional to their usefulness.

Avoiding emergent risks by having expert managers to scan the horizon for them as you go is a full-time, up-front cost and, you know, if you pay monkeys you get peanuts.

Setting limits and then managing them is easier, seeing as a machine can do the heavy lifting there, but you generally need risk officers to set the limits and operations staff to keep an eye on them.

Enforcement is a bit cheaper yet: there’s all that unseemly haggling about NAV triggers upfront of course, but then, beyond monitoring to see if they have been hit, which is no more of a burden than monitoring credit lines, it is free, for all agreements, for all times, except those troublesome handful you actually need to enforce. Even that is pretty cheap, if you have been margining properly but should you get into a squabble that needs a court to sort it out, those costs will rise.

There is also a halfway house which is having legal protections but, having signed the docs in 2003 and stuck them in a drawer, not knowing what they are quand le merde se frappe le ventilateur, and only then finding out through the voyage of discovery which is calling up the legal eagles and asking what them what the hell to do.

Exoneration, needless to say, costs nothing day-to-day until after the fact, at which point it is both useless and ineffective. If the loss threshold is high enough, you will get fired.

So what is the lesson with coping strategies? You get what you pay for.

Accidents

From Charles Perrow’s The Next Catastrophe: accidents will happen. Four strategies for coping: three focus on the accident, one focuses on your organisation.

The Accident
  • Minimise chance that accidents happen.
  • Limit damage accidents can cause.
  • Reduce vulnerability to accidents.
  • Respond when accidents happen.
Vulnerability to accidents

Assuming accidents will happen, reduce vulnerability to them. Vulnerability comes in the form of unusual concentrations:

  • Energy: in a financial services firm, call this financial risk, or profit-and-loss generators
  • Population: different models of distributed network. Compare “hub and spoke” models like airports (fragile — take out a hub and large parts of the system are inoperable) with “multiple-node” networks like the internet (robust — take out a node and everything can flow a different way).
  • Political power: increases the vulnerability to harm from executive failure.
Avoidance Damage Limitation Reaction Aftermath
Strategies Know your client; have good data

Manage relationship

Monitor trades

Due diligence

Credit lines

Trading limits

Red flags

Security/collateral

Close-out

Events of default

Security

Internal enquiry

Regulatory enquiry

Litigation

Disciplinary

Environment Calm, orderly, timely, systematic, thorough, inquisitive, patient.

The object is not to be satisfied there is no risk but to to identify where is the risk.

On alert.

Stressed, but solvent.


Chaos: Panic, Urgency, Volatility, Fog of war


Recriminatory

Coloured by hindsight

Constructing a new narrative

Designed to attribute blame (elsewhere)

Information quality High; unpressured.

Good lines of communication, functioning well.

Adequate. Communication will deteriorate as the situation gets worse. Counterparts may be economical with information At this point, it is likely the information you had was already bad; it will now be worse Limited: slow to emerge; vetted; filtered; coloured; constrained; restricted to “optimising facts”
Effectiveness High Medium Low Hostile