Platt Perspective on Business and Technology

Regulatory oversight, prudent business practices and risk allocation – 2: preparing for impending change

Posted in macroeconomics by Timothy Platt on November 10, 2012

This is my second installment in a series on best practices for developing and managing a business more effectively in the face of outside regulatory challenge, and with a goal of offering a best practices approach for competitively operating in a regulated environment (see Part 1: setting a foundation for discussion.) And at the end of Part 1, in in anticipation of this posting I intentionally set up what is sometimes referred to as a straw horse – a point of argument that from internal flaws cannot stand up to scrutiny, at least as specifically stated. Specifically, at the end of my first series installment I posited three points for further discussion:

1. Planning for upcoming regulatory change, and knowing precisely what your business will face and where it will have to do things in new ways,
2. Strategically and operationally planning how best to change to accommodate that in satisfying regulatory requirements, and
3. Identifying and acting upon processes and functionalities in your business where you can still create opportunity, where your business can still be flexible and agile.

And the problem in this is built into the first of these three points and how it is formulated. Quite simply, it is never in the real world going to be possible to know precisely what any business will face and in all details moving forward. Business strategy is, or at least should always be about planning for contingencies and with allowance and flexibility built in for the unexpected. And starting this posting from that point, I invoke a basic strategic systems taxonomic distinction that I have been discussing and developing for its implications in other recent postings: the concepts of fragile and robust business strategy (see Operational Failure Rates, Feedback and Remediation, and Risk Remediation Processes 3.)

• As regulatory oversight and its interpretation and implementation through the courts and case law are a part of the context that every business operates in, in their marketplaces, effective businesses are the ones that proactively seek to develop and maintain a strategic robustness in the face of change and uncertainty coming from regulatory law and its requirements.

So effective businesses plan for what is known and predictable in meeting their regulatory requirements, and given the timeframes involved in developing and implementing these laws that can mean strategically planning from a fairly certain basis of understanding, and for many if not most of the key details that will have to be operationally addressed. But with the unpredictable challenges coming from unexpected court interpretations that can tighten or redirect or loosen or even invalidate regulatory law provisions, effective business strategy is always left open to the possibility of having to develop a Plan B approach and even on the fly.

To take this out of the abstract, I would cite an all too evident strategic fragility as businesses would address regulatory oversight and due diligence concerns, shown by way too many financial institutions going into the Great Recession. Specifically, I would cite how regulatory law was outdated and weakened governing the assembly and structuring of bundled investment instruments, for their overall risk levels and note that much of that recession arose when so many financial institutions and their investors found themselves holding toxic investments, overbalanced for high risk content. And these firms were all way over-leveraged, and the investments that they offered in way too many cases were found to be collectively and as bundled investments, worthless. The “all too evident” of that, unfortunately only became clear in hindsight as the house of cards collapsed. And the strategic fragility in this and its operational consequences stemmed from the limited and even purblind ways in which these institutions made use of historical trends data to assess risk in contexts that their historical data could not address. So the points I raise here in this series are important to individual businesses as they seek to create long-term and sustaining strength and marketplace capability. But on a larger scale they are also important to entire industries and marketplaces and even to entire economies. For the financial industry collapse and the Great Recession it created, we will all be dealing with long term consequences for years to come, and even as the recession itself has been formally over for several years now. (I am planning on addressing this example in greater detail in an upcoming posting in a separate series.)

And with that, and starting with a non-deterministic, probabilistic understanding of the issues glossed over in my first point, above, I turn to points two and three. Meanwhile, you can find this and related postings at Macroeconomics and Business.

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