Wall Street & Technology is part of the Informa Tech Division of Informa PLC

This site is operated by a business or businesses owned by Informa PLC and all copyright resides with them. Informa PLC's registered office is 5 Howick Place, London SW1P 1WG. Registered in England and Wales. Number 8860726.

Risk Management

10:22 AM
Andrew Waxman
Andrew Waxman
Connect Directly

The Case for Scenario Planning in Sandy’s Wake

After underestimating the strength of Hurricane Sandy, financial firms need to consider 'risk scenario planning' as a tool for forecasting what can go wrong in the future, writes author and risk analyst Andrew Waxman.

In the aftermath of Super Storm Sandy, various articles have pointed out the gap between the size of the storm’s accompanying storm surge and the magnitude of such an outlying event planned for by New York City and New Jersey. What was expected by man was much smaller than what was delivered by nature. A real question is: were the expectations upon which business continuity plans and infrastructure based, reasonable, given existing data and trends? How do we plan more effectively for such events in the future? Scenario analysis offers one useful approach.

Industry and its infrastructure have of course always, been vulnerable to catastrophes both of nature's and its own making. The impacts of terrorism, earthquakes and fraud have all been seen on industry in the past decade. The problem of determining the likelihood and impact of a terrorist attack, a large oil spill or a massive hurricane like Sandy is inherently hard to solve for. However, it is a critical step to take if one is to appropriately address each type of risk. Over-estimating size and frequency of future events can result in wasted resources. Yet, natural inertia, ingrained optimism, and pressure of the day to day can lead to a fatal failure for disaster planning to keep up with the level of potential danger as it ebbs and flows. Reviewing the many business continuity plans of firms impacted in ways by Sandy that were unexpected and unplanned for, it is clear that this is what happened in this case.

There is clearly a need to strike the right balance between wasted resources and much needed investment in preventive or mitigating systems. One useful tool developed to address this issue is risk scenario planning. In broad terms, scenario planning assesses alternate scenarios of how things could go very badly wrong in the future. These scenarios are subject to discussion and dialogue between subject matter experts and organization budget managers in a workshop setting. Data is brought to the table to frame the discussion, including, case studies of past events and their associated impacts. While having a good understanding of what happened in the past is critical, it is not sufficient for imagining, in the context of a dynamic constantly changing system, what could go wrong in the future. A more accurate forecast depends on an honest appraisal of the effectiveness of those things put in place to prevent or to mitigate future events; and ideally, other information that sheds light on the current likelihood or impact of future events. In the context of volatile weather, this could be broad trends on ocean levels, size and frequency of hurricanes potentially in the path of the city and the ability of safeguards put in place to prevent or mitigate the damage to a firm’s infrastructure.

The real power of scenario planning is based on two somewhat qualitative and behavioral aspects. First, taking leaders and subject matter experts away from the day to day exigencies of their work allows them to focus on those risks that have the power to take away their work on a permanent basis.

Second, giving space and opportunity for the imagination to crawl through the data, visualize real scenarios that could happen, and honestly evaluate those things that have been put in place to prevent or mitigate such events is surprisingly underestimated as a management tool. The absence of that opportunity can lead to an absence of imagination that is potentially fatal. With the key leaders in the room, decisions can be made on the spot to shift resources and focus accountability for addressing the “top risks” that face the organization in more effective ways. This has helped organizations who use this tool to improve their level of preparedness quite significantly.

As we now stand in the shadows of Katrina and Sandy that have wrought such incredible human and physical damage to two major US cities and their associated businesses and infrastructure, it is appropriate to take a step back. To help do so, financial firms should utilize tools that can help evaluate the received wisdom regarding so called "black swan", once in a lifetime weather events. Given the arrival of two, maybe three such events on US eastern shores in the past decade, the time to do so is long overdue. Scenario planning workshops facilitated with the most senior leaders of the firm and even their partners in government could help our firms to better prepare for such events in the future.

—Andrew Waxman is an author and risk analyst who has worked for both consulting and investment banks during his career in the City of London and on Wall Street.

Andrew Waxman writes on operational risk in capital markets and financial services. Andrew is a consultant in IBM's US financial risk services and compliance group. The views expressed her are those of his own. As an operational risk manager, Andrew has worked at some of the ... View Full Bio
More Commentary
A Wild Ride Comes to an End
Covering the financial services technology space for the past 15 years has been a thrilling ride with many ups as downs.
The End of an Era: Farewell to an Icon
After more than two decades of writing for Wall Street & Technology, I am leaving the media brand. It's time to reflect on our mutual history and the road ahead.
Beyond Bitcoin: Why Counterparty Has Won Support From Overstock's Chairman
The combined excitement over the currency and the Blockchain has kept the market capitalization above $4 billion for more than a year. This has attracted both imitators and innovators.
Asset Managers Set Sights on Defragmenting Back-Office Data
Defragmenting back-office data and technology will be a top focus for asset managers in 2015.
4 Mobile Security Predictions for 2015
As we look ahead, mobility is the perfect breeding ground for attacks in 2015.
Register for Wall Street & Technology Newsletters
Inside Abel Noser's Trading Floor
Inside Abel Noser's Trading Floor
Advanced Trading takes you on an exclusive tour of Abel Noser's New York trading floor, where the agency broker known for transaction cost analysis, is customizing algorithms for the buy side, while growing its fixed income trading and transitions business.