Comments for Harrison, Stone & Associates http://www.harrisonstone.com Tue, 14 Feb 2012 18:44:03 +0000 hourly 1 http://wordpress.org/?v=3.3.1 Comment on Living Wills: What if Risk Management Fails? by Simon Hu http://www.harrisonstone.com/risk-management/living-wills-what-if-risk-management-fails/#comment-4 Simon Hu Tue, 14 Feb 2012 18:44:03 +0000 http://www.harrisonstone.com/?p=570#comment-4 The basic objective of SIFI living will is to preserve going concern (GC) value of SIFIs in vicinity, or zone of insolvency. In addition, the concept of going concern is widely used in other financial regulations such as Basel III and Solvency II. However, GC is a regulatory compliance tool, not a risk reporting and disclosure tool by way of its binary "going concern" and "gone concern" structure. In IAS 1 of IFRS, it is management's primary responsibility to provide GC assessment. However, FASB recently decided not to make GC assessment a primary responsibility for management in GAAP. In auditing, the AICPA's SAS 59 has not converged with IAASB's ISA 570 because they are waiting for FASB's completion of the "Disclosure about Risks and Uncertainties" project. In S&P and Fitch's rating methodology for SIFI Coco bonds, "going concern" and "going concern trigger" are left undefined. It appears that the GC concept is ubiquitously present in financial regulations and credit rating methodology, but everyone left the foundation undefined. The challenge in implementing these regulations that are based on the GC concept, therefore, is who would decide what is "going concern" and dintinct it from "gone concern". This is clearly beyond the current binary "pass or fail" GC audit model. Going concern rating redefines the traditional concept of going concern rating by inserting a rating scale and the concept of zone of insolvency, and rates GC risk and credit risk on the same rating scale with dynamic equity-debt notching which is defined by actual allocation of and potential claims on cash flow. GC rating measures the gradation of GC risk on a rating scale, which provides a pre-defined path to insolvency and has significant analytical utilities to the new regulatory reporting and disclosure requirement. Therefore, some of the challenges in implementing SIFI living will, such as insolvency declaration of global SIFI, could be simply resolved by a pre-defined GC rating trigger. My research is published at http://www.palgrave-journals.com/jdg/journal/v8/n4/abs/jdg201115a.html and I would be happy to further discuss. Simon Hu The basic objective of SIFI living will is to preserve going concern (GC) value of SIFIs in vicinity, or zone of insolvency. In addition, the concept of going concern is widely used in other financial regulations such as Basel III and Solvency II. However, GC is a regulatory compliance tool, not a risk reporting and disclosure tool by way of its binary “going concern” and “gone concern” structure. In IAS 1 of IFRS, it is management’s primary responsibility to provide GC assessment. However, FASB recently decided not to make GC assessment a primary responsibility for management in GAAP. In auditing, the AICPA’s SAS 59 has not converged with IAASB’s ISA 570 because they are waiting for FASB’s completion of the “Disclosure about Risks and Uncertainties” project. In S&P and Fitch’s rating methodology for SIFI Coco bonds, “going concern” and “going concern trigger” are left undefined.

It appears that the GC concept is ubiquitously present in financial regulations and credit rating methodology, but everyone left the foundation undefined. The challenge in implementing these regulations that are based on the GC concept, therefore, is who would decide what is “going concern” and dintinct it from “gone concern”. This is clearly beyond the current binary “pass or fail” GC audit model.

Going concern rating redefines the traditional concept of going concern rating by inserting a rating scale and the concept of zone of insolvency, and rates GC risk and credit risk on the same rating scale with dynamic equity-debt notching which is defined by actual allocation of and potential claims on cash flow. GC rating measures the gradation of GC risk on a rating scale, which provides a pre-defined path to insolvency and has significant analytical utilities to the new regulatory reporting and disclosure requirement.

Therefore, some of the challenges in implementing SIFI living will, such as insolvency declaration of global SIFI, could be simply resolved by a pre-defined GC rating trigger. My research is published at http://www.palgrave-journals.com/jdg/journal/v8/n4/abs/jdg201115a.html and I would be happy to further discuss.

Simon Hu

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