Balanced Scorecard Report

F I L E

Leadership and Strategic Risk Numerous tools are available

to help companies identify risk
Management: An SFO Approach factors and assess risks. But risk
management is as much—if not
C A S E

Based on a presentation by Jack Klinck, Executive Vice President and Global more—a matter of sound leader-
Head of State Street Alternative Investment Solutions, at the Palladium Group’s ship and governance than it is
April 2009 Strategic Risk Conference about creating new analytics and
metrics. Risk management is
How can risk management be fixed? Banking executive Jack
about building a new approach
Klinck (and former chairman of BSC Hall of Fame company into an existing process (strategy
Mellon Europe), offers two solutions, neither requiring a new management). It involves a shift
framework or process. First, since risk management is both in orientation—looking at per-
a strategic and a defensive discipline, it must be unsiloed formance from the flip side—
and integrated with strategy management. Second, it must whether to understand the impli-
be directly linked to leadership—and leaders must foster a cations of skyrocketing sales
culture of risk-mindedness. The five principles of the Strategy- (suggesting not only marketing
Focused Organization provide an excellent model for helping success but also, say, a slip in
embed risk management into the corporate DNA. client acquisition standards) or
the impact of staff cuts on client
The global financial crisis has taneously. Fourth, the fragmented servicing.
prompted financial services firms regulatory environment reinforced
How can an organization bring
to reevaluate their assumptions the notion of risk as solely a
risk to the forefront of its man-
about the way they manage compliance issue. Finally, the push
agement process? One way is by
risk and the internal discussions for high profits in the short term
trying to better understand how
they hold about risk, both at the became so extreme that many
the risks in one business unit or
board and management-team players looked past the risks they
line affect another. An enterprise
levels, noted Jack Klinck. Klinck were taking.
may have dozens of relationships
heads State Street Corporation’s
The crisis, Klinck noted, caused with one client. What does that
Alternative Investment Solutions
managers across his bank’s busi- mean in terms of its overall risk
(AIS) unit, which provides fund
ness units to look with fresh eyes exposure—and that of any indi-
accounting, fund administration,
at how they were managing their vidual unit? During the peak of
and risk services for approximately
businesses. They realized manage- the financial crisis, said Klinck,
$400 billion in alternative assets,
ment was vertically oriented, with “we realized we weren’t evaluat-
including hedge funds, private
not enough consideration of the ing the product overlap with
equity funds, and offshore funds.
horizontal interrelationships and many of our clients and counter-
With the flood of analysis (and of the ways each business affected parties.” Today, he added, it’s
the benefit of hindsight), many the others. important to ask your manage-
causes of the financial crisis ment teams, “Are you having the
are familiar by now. From a risk Making Risk Management Part right conversations across the
perspective, said Klinck, there of the Corporate DNA business to identify and manage
were five basic triggers. First, Risk management is both a strate- strategic risk?” “Are your people
financial services firms were confi- gic and a defensive discipline, as paying attention to what the
dent they could contain product it touches every type of external performance indicators are telling
risk by slicing it and packaging and internal threat, known and them—and about the indicators’
the pieces as securitized invest- unknown—from financial risk impacts on other performance
ments. As the packages became to competitive threats, and from areas?” And perhaps most impor-
more mixed, the underlying reputational risk to event risk. tant, “Are you listening to your
risks became obscured. Second, Because risk permeates every area people?” Ultimately, an organiza-
because risk management was and aspect of business, a siloed tion’s people are its best leading
siloed by type of risk (credit, approach to managing risk makes indicators.
operational, market, counterpar- no sense. Companies not only State Street AIS already had in
ty), managers misunderstood risk need to adopt a holistic view of place several management tools
correlations among assets. Third, risk, but they must also integrate and techniques—notably, strategy
the industry ignored the potential risk management into their overall maps and Balanced Scorecards
for systemic risk—defaults and management system so that it (BSCs). As a self-professed fan
other risk events occurring simul- is part of their corporate DNA. of the Kaplan/Norton Strategy

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Balanced Scorecard Report: The Strategy Execution Source, ©2009 Harvard Business Publishing and Palladium Group, Inc. and used by permission.

Management system for several
years, Klinck felt it was only
natural to mirror this approach
for building strategic risk manage-
ment into the organizational
DNA. He saw no need to invent
a new framework or process
for managing risk. “By tying risk
management to our existing
strategic framework, we’ve been
able to implement what we con-
sider a sound, sensible, eminently
The Role of the Theme
Team in Risk Management
Although their focus is strategy,
strategic theme teams are an
invaluable mechanism for risk
management as well. When the
financial crisis struck, State Street
AIS’s theme teams provided a
natural forum for discussing
key issues across its businesses.
Management quickly got valu-
able insights about the changing
markets, and the teams high-
lighted emerging risks that
could affect many areas of the
business.
Theme teams assemble and
circulate Balanced Scorecard
performance reports before every
strategy review meeting. As front-
line analysts, they help ensure
that discussion is driven deep
into the organization and that
response takes place at the right
level. Theme teams discuss the
strategic implications of the sub-
par objectives along with those
in the green, objectively noting
the biggest risks to the strategy
and the business. They can per-
form in-depth analysis to uncover
the drivers of a potential risk, to
conduct scenario planning, and
simply to generate creative new
ideas. They can bring together
management from different
areas of the organization—and
of the entire enterprise—to
explore issues and find holistic
solutions. During the crisis,
AIS’s theme teams met more
frequently, to facilitate rapid
response and organizational
learning.
Balanced Scorecard Report: The Strategy Execution Source, ©2009 Harvard Business Publishing and Palladium Group, Inc. and used by permission.
feasible approach to risk manage-
ment.” The strategy map and BSC
provided a flexible framework for
clarifying priorities, adjusting the
emphasis of specific themes as
needed, recalibrating targets, and
reprioritizing initiatives—while
maintaining the underlying strategy.
The Five Principles of
Managing Risk
State Street AIS’s approach to
risk management roughly follows
Kaplan and Norton’s foundational
principles for strategy manage-
ment: the five principles of the
Strategy-Focused Organization.
(See Figure 1, next page.)
1. Executive leadership. First
and foremost, senior manage-
ment, and not only the chief risk
officer (CRO) or the risk manage-
ment group, should be responsi-
ble for risk management. (The
converse is also important; AIS’s
head of risk, for instance, as part
of the senior management team,
participates in all strategy review
meetings and key decisions.)
A leader’s enlarged role in risk
management, by the way, does
not mean that the CRO’s role is
reduced. In fact, the CRO must
work with the businesses and
manage the “escalation procedures”
—all the steps involved in a risk
mitigation effort. The CRO’s inde-
pendence ensures that senior
managers aren’t tempted to unduly
influence or compromise any
standards and that they balance
responsibility with authority.
As organization leader, Klinck
sets the appetite for and approach
to risk, clarifying the strategic
direction and path to getting
there. For example, the leading
private equity administration
business that State Street AIS
acquired in 2007 had been
growing at a rate of 35% a year.
Establishing a risk management
infrastructure and culture from
the start was critical. “We aligned
the private equity unit’s strategic
objectives to AIS priorities and
collaborated on devising client
November–December 2009
acquisition criteria.” The leader-
ship team, Klinck added, also pro-
vides the model for values and
behavior. That includes cultivating
not only risk-mindedness but also
team members’ willingness to be
candid in assessing performance,
rather than sugarcoating the
picture for the boss.
Because State Street AIS grew
through a number of acquisitions,
it was particularly important that
the unit understand the way each
of its three groups affects the
others. Besides recognizing the
need to create a coordinated
approach to marketing and client
service (to minimize client confu-
sion) and the need for an inte-
grated approach to technology (to
ensure seamless client servicing),
senior management saw the need
to develop coherent standards for
risk management among the
acquired units. For example, the
leadership team strenuously
debated managing client acquisi-
tion risk: How can the company
achieve business growth targets
while avoiding clients that don’t
match the organization’s strategic
risk profile? Few organizations
allow such debate, Klinck noted.
But, he added, “we’re convinced
that when the financial crisis
hit, AIS was in a much stronger
position than many of our
competitors.”
2. Measurement. The same BSC
measures that provide an early
indication of strategic performance
success or failure also serve as
key risk indicators when analyzed
from a 360-degree perspective.
The red/amber/green “traffic
light” assessment on the strategic
objectives, measures, and initia-
tives shows—in the context of the
whole strategy map—how subpar
performance puts other goals at
risk. Thus, this assessment gives
managers the ability to respond
rapidly with corrective action. The
color-coding provides in effect a
“heat map” of key strategic issues,
showing their connection with
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 Balanced Scorecard Report
other indicators and helping the
organization identify trends and
gain insights. For example, an
amber rating on a sales win/loss
analysis metric would suggest not
only that sales losses are in line
with projections but also that wins
may be declining—a risk that
would need to be investigated.
3. Alignment.The strategy map
and strategic themes provide the
structure for aligning businesses,
teams, and individuals to the
organization’s common goals.
Alignment also encompasses
risk. Said Klinck, “We look at our
themes and objectives to ask,
‘Will they promote the right
behaviors—or create conflicts?’
For example, ‘Are our incentives to
grow promoting undue risk taking?
Are we investing in the right
places in product development
to meet the latest marketplace
requirements for transparency?’”
The strategy map thus serves
equally as a “shared risk agenda.”
4. Engagement. An organiza-
tion’s staff is probably the most
effective leading risk indicator.
“We try to engage staff as much as
possible” and to listen carefully to
people throughout the organiza-
tion, noted Klinck. Well before
Figure 1. The Five Principles of Strategic Risk Management
1. Executive
Leadership
2. Measurement
Strategic Risk
Management
3. Alignment
Strategic risk management parallels the approach to strategy management embodied in
Kaplan and Norton’s five principles of the Strategy-Focused Organization.
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Balanced Scorecard Report: The Strategy Execution Source, ©2009 Harvard Business Publishing and Palladium Group, Inc. and used by permission.
the financial crisis, State Street AIS
already had in place a culture
that encouraged employee dissent
and candor in discussing strategic
issues. Developing the business
unit strategy maps generated
awareness and ownership of AIS’s
strategic priorities and of the role
each business has in contributing
to them. Its theme teams bring
together a broader group of
people involved in strategy imple-
mentation. Yet another group is
developing initiative teams. Every
quarter, the executive team holds
a town hall meeting at a key loca-
tion to provide a forum for open
discussion with local leaders.
5. Governance. Traditionally,
governance in financial services
firms occurs mainly through
the business units, resulting in
a siloed approach to managing
risk and strategy. A solid gover-
nance structure can help empha-
size the mutual impacts of different
groups or performance drivers,
at the same time ensuring that
dialogue occurs horizontally and
at multiple levels.
Strategy review meetings are
as critical to risk management
as they are to strategy review
itself. At AIS’s monthly strategy
5. Governance
4. Engagement
review meetings, the strategy
map is assessed as a whole.
Klinck and his team review the
heat map of red/amber/green
ratings of performance against
objectives, examining the ratings’
implications and ramifications.
Then they explore a given strate-
gic theme in detail. Each strategic
theme owner leads a discussion
on the assessment results, looking
at their impact on strategic out-
comes, both negative and positive.
“We actively debate the risks
and implications—focusing on
the horizon, not the past,” said
Klinck. “This approach allows us
to manage strategic risk even in
the absence of perfect measures.”
To be robust, a strategic risk man-
agement approach must embed
risk management into the organi-
zation in good times as well as
bad. It must treat risk holistically,
as an integral part of strategy and
performance management. In this
way, organizations can adapt to
change—even rapid change—with
speed and agility. “We hope,” said
Klinck, that “by recognizing the
importance of a proactive, holistic
approach, the entire financial
services industry will emerge
from this crisis stronger.” I
Prior to joining State Street AIS, Jack
Klinck was vice chairman of Mellon
Financial Corporation and president of
the Investment Management Solutions
Group. Previously he was chairman of
Mellon Europe. Early in his tenure there,
he introduced the Balanced Scorecard
management system; in 2004, Mellon
Europe was inducted into the Balanced
Scorecard Hall of Fame for Executing
Strategy.
T O L E A R N M O R E
See “Mellon Europe: Mobilizing
Change Through Executive Lead-
ership,” in BSR January–February
2005 (Reprint #B0501F). Also
see Mellon Europe’s write-up in
the Balanced Scorecard Hall of
Fame Report 2005 (Product
#9157). Both are available at
www.harvardbusiness.org.
Reprint #B0911C