Systemic Risk A Primer for Boards and Senior Executives

BY

Dr Robert Flynn, Managing Director, VUCA Concepts

Volatility Uncertainty Complexity Ambiguity

Foreword

I invite you to take the five minutes needed to skim through this thought-provoking overview of systemic risk.

It is presented in storyboard format so as to take up as little of your time as possible.

The reader can choose to view just the first fourteen slides. These provide a helpful preliminary overview.

The three appendices put some more ‘meat on the bones’.

We’ll proceed by addressing four key questions:

1. What is systemic risk?

1. “Why should we care?”

1. How can the VUCA Concepts consulting consortium help you?

2. What is ‘Tartarus’ and what does it involve?

QUESTION 1

What is systemic risk?

A form of risk exposure accentuated by inability to deal effectively with the escalating levels of

VOLATILITY – UNCERTAINTY – COMPLEXITY – AMBIGUITYin contemporary global markets.

It is a particular concern for industries where safety, socio-economic, eco-environmental and geo-political sensitivities are of paramount

importance.

A form of risk exposure accentuated by inability to deal effectively with the escalating levels of

VOLATILITY – UNCERTAINTY – COMPLEXITY – AMBIGUITYin contemporary global markets.

It is a particular concern for industries where safety, socio-economic, eco-environmental and geo-political sensitivities are of paramount

importance.

A brief introduction follows on the four components of VUCA-based risk.

VOLATILITYThe sheer speed with which the world is changing – the nature, magnitude and dynamics of the transformations taking place in social, political, economic and technological conditions.

Components of VUCA

UNCERTAINTYLack of sureness and an abundance of unpredictability.

Often made more intense by the fact that ‘we don’t know what we don’t know!’

What Russell Ackoff called the sheer ‘messiness’ of many organisational situations!

Brought about by multiple interactions of individuals, groups, events, issues, ideas, facts, values, dramas, half-truths, hidden agendas, irreconcilable differences, et cetera.

COMPLEXITY

Components of VUCA

The ‘haziness’ of some situations with which we are faced.

Characterised by paradox, mixed meanings, competing interpretations, differing perspectives among key players, and so forth.

AMBIGUITY

“Am I looking at a vase or two people facing each other?”

QUESTION 2

The “Why should we care?” question

As a board member/senior executive in an enterprise with potential for systemic risk exposure, you should be concerned for the following reason:

Inability to detect, interpret, specify and manage this subtle but insidious exposure can lead to ‘drift into failure’.

The outcome can cash out somewhere betweenVERY COSTLY TO CATASTROPHIC !

Inability to detect, interpret, specify and manage this subtle but insidious exposure can lead to ‘drift into failure’.

The outcome can cash out somewhere betweenVERY COSTLY TO CATASTROPHIC !

Take particular note if you are in the extractive industries, energy or large-scale construction

sectors!

Some examples of where systemic risk wasn’t managed very well.

CHERNOBYL (UKRAINE)DEEP WATER HORIZON

(USA)

LONGFORD GAS PLANT(AUSTRALIA)

CHALLENGER SHUTTLE DISASTER(USA)

QUESTION 3

How can the VUCA Concepts consulting consortium help you?

Together with our global consortium partners, we bring over thirty years of deep understanding of the mining, oil & gas, energy and construction sectors, particularly from a socio-economic and geo-political perspective.

VUCA Concepts itself brings world-class expertise in applying analytical and modelling techniques, drawn from Complexity Science, for the purpose of identifying, interpreting, assessing and mitigating systemic risk exposure.

In combination, we have developed a proprietary protocol for managing and mitigating systemic risk exposure under VUCA conditions.

We call this protocol Tartarus!

In combination, we have developed a proprietary protocol for managing and mitigating systemic risk exposure under VUCA conditions.

We call this protocol Tartarus!

A brief account of Complexity Science is given in Appendix A.

QUESTION 4

What is Tartarus and what does it involve?

Tartarus is the name we use for our proprietary systemic risk management protocol.

Why Tartarus?

In Greek mythology Tartarus is one of the primordial deities. Specifically, he is the god of the deepest, darkest part of the underworld, the so-called Tartarean Pit.

The term draws attention to the fact that the root causes of systemic risk invariably lie well outside the ambit of traditional risk management scrutiny. This tends to focus on the potential for damage or de-stabilisation at the level of either (a) observable events, mistakes and issues, or (b) detectable trends and trajectories negatively affecting the business.

But for its part, the root causes of systemic risk invariably reside

deep within the ‘cultural underbelly’ of the organisation,

well out of sight from normal risk management scrutiny, and usually

touching on all sorts of cultural and political sensitivities and

‘undiscussables’.

In a nutshell, Tartarus……

… is underwritten by a set of six key Organising Principles.

… is activated via a series of Sequential Steps. These vary from situation to situation, but will typically include five core components.

… employs a comprehensive range of (a) methodologies and (b) investigative, interpretive and modelling techniques from Complexity Science that enable the identification and gradual removal of the factors underpinning systemic risk.

Appendix B provides further introductory information on Tartarus.

Thank you for taking the time to read through this brief overview of systemic risk. We trust it provides food for

thought.

Should you like to have a more detailed presentation, and in particular to discuss your own potential exposure to

systemic risk, in the first instance please contact:

Dr Robert FlynnTel +61 408 524 746Email robert.flynn@vucaconcepts.com.au

VUCA Concepts is a Melbourne, Australia

based firm of Organisational Complexity

Analysts.

We apply our specialist knowledge and skills to help clients reduce their exposure to systemic risk, unravel

intractable (‘wicked’) problems, improve project performance, and factor in the likely impact of VUCA

conditions into their strategic and operational planning.

APPENDIX A

Complexity Science

A Brief Introduction

Complexity Science is a collection of ideas focused on understanding the dynamics of change in different natural and

social systems.

It is a loosely bound collection of inter-disciplinary ideas, principles and influences from a number of diverse bodies of knowledge, including:

•chaos theory•fractal geometry•system dynamics•cybernetics•complex adaptive systems theory•critical hermeneutics•anthropology•sociology•cognitive science•postmodernist theory•systems thinking

Applying the methods of Complexity Science enables the discovery of patterns, processes and relationships as they relate to the nature and

dynamics of change in living systems.

Complexity concepts provide ways of thinking about, interpreting, and making accurate sense of…

• The nature of systems

• How systems change

• Human actions and behaviours

APPENDIX B

TARTARUS

Additional Information in 3 Parts

B1 Organising PrinciplesB2 Activation StepsB3 Methodologies & Techniques

Appendix B1

Tartarus Organising Principles

OP 1 Complex Systems

The root cause of systemic risk invariably lies within ‘complex systems’ that have been allowed to drift into dysfunctionality.

Appendix B1 Organising Principles

Implication

In the first instance you must have the ability to recognise a complex system; specifically, you must be able to distinguish it from the three other generic system types that are part and parcel of organisational life.

Appendix C provides a brief overview of the four generic types of system.

OP 2 Interpretive Frameworks

To effectively understand complex systems requires a set of interpretive frameworks based on non-linear, dynamic, reflexive thinking. Complexity Science provides the theoretical foundation for these frameworks.

Implication

If you’re serious about minimising your exposure to systemic risk, you must adopt and learn how to apply these frameworks. (Caveat: the competency set required for doing this doesn’t come naturally to the majority of those trained in scientific and engineering disciplines. This is not a criticism, but suggestive of a certain type of intellective architecture required for dealing with complex problem situations.)

Appendix B1 Organising Principles

OP 3 Rigour & Persistence

There are no ‘quick fixes’ to the complex problem situations that represent the root cause of systemic risk.

Implication

Reducing your exposure to systemic risk requires intellectual rigour. It also requires a type of patient persistence not always found in our boardrooms and executive corridors, where desire for quick solutions often dominates.

Appendix B1 Organising Principles

OP 4 Requisite Variety

In order to deal effectively with the diversity of problems the world throws at you, you need to have a repertoire of responses which is (at least) as nuanced as the problems you face.

Implication

It is very important to recognise that not every senior leader will have the cognitive architecture needed for grasping the notion of systemic risk. For some it will be so counter-intuitive as to be out of reach. The key is to give these highly complex problem situations to only those with the requisite intellectual ‘bandwidth’. Not doing so is akin to asking a plumber to re-wire your house!

Appendix B1 Organising Principles

OP 5 Pattern Recognition

The process of mitigating systemic risk depends on an ability to recognise the archetypal patterns of behaviour that explain why dysfunctional complex systems persist in your enterprise.

Implication

Once recognised, you must then have both the leadership courage and technical capacity to break these dysfunctional behaviour patterns, which brings us back to the need to employ the methodologies and techniques of Complexity Science. (See Appendix B3 for further detail.)

Appendix B1 Organising Principles

OP 6 Cycles & Engines

The application of Complexity Science highlights the existence of ‘vicious cycles’ that need to be broken, and the potential for ‘engines of growth’ that need to be developed and activated in your business.

Implication

An important secret for effectively managing your exposure to systemic risk is learning how to progressively break the vicious cycles and quickly replace them with engines of growth.

Appendix B1 Organising Principles

Appendix B2

Tartarus Activation Steps

STEP 1 Initiation & Contracting

Secure a senior-level sponsor – ideally the CEO or divisional head – to ensure the requisite level of ‘buy-in’ for the process to succeed with sufficient commitment.

STEP 2 Mapping the Territory

Conduct a preliminary investigation, paying particular attention to the historical trajectory that has led to the current level of systemic risk exposure.

STEP 3 Detailed Forensics

Employ specialist investigative and modelling techniques from Complexity Science to identify the root causal structures underpinning the exposure levels.

STEP 4 Interpretation

Employ specialist interpretive techniques to identify where the ‘high leverage intervention points’ reside for unravelling the complex structures giving rise to the systemic risk factors.

STEP 5 Design & Deployment

Design and deploy the necessary remedial steps, and carefully project manage the process.

Appendix B2 Activation Steps

The following five steps are invariably part of the implementation process:

Appendix B3

Tartarus Methodologies & Techniques

METHODOLOGIES

Depending on circumstances, we typically employ one or more of four collaborative planning/problem-solving methodologies:

1. Interactive Planning (as developed by Russell Ackoff)

2. Design Thinking

3. Resolution Mapping

4. Soft Systems Analysis (Checkland method)

Appendix B3 Methodologies & Techniques

The interested reader can explore all four further via a Google search.

TECHNIQUES

Again, depending on circumstances, we will typically employ some combination of the following:

• Complexity Mapping• Rich Picture modelling• Purposeful Activity Systems modelling• BATWOC Profiling• Representational Art modelling• Root Cause Analysis• Causal-Loop Analysis• Counterfactual Analysis• Visual Analytics• Risk Sensitivity Profiling• Critical Thinking

Appendix B3 Methodologies & Techniques

Note that most of these methods, drawn from Complexity Science, have not traditionally been taught in our engineering schools and

natural science departments.

APPENDIX C

The Four Generic Types of System

Brazilian RainforestA COMPLEX system

Lamborghini SportscarA COMPLICATED system

Building on FireA CHAOTIC systemSponge Cake

A SIMPLE system

DISTINGUISHINGMETAPHORS

SIMPLE CAUSE-EFFECT PROFILE: LINEAR; OBVIOUS; REPEATABLE; PREDICTABLE

EPISTEMIC PROFILE: KNOWN ‘KNOWNS’

STANDARD: BEST PRACTICE

DECISION MAKING HEURISTIC: RTS - CATEGORISE - RESPOND

APPLY: STANDARD OPERATING PROCEDURES

CHAOTICCAUSE-EFFECT PROFILE: NONE IN EVIDENCE; NOT IMMEDIATELY RELEVANT

EPISTEMIC PROFILE: RETROSPECTIVE ‘KNOWNS’

STANDARD: APPROPRIATE PRACTICE

DECISION MAKING HEURISTIC: ACT - RTS - LEARN

APPLY: STABILISING ACTIONS

COMPLICATEDCAUSE-EFFECT PROFILE: LINEAR; DISCOVERABLE

EPISTEMIC PROFILE: KNOWN ‘UNKNOWNS’

STANDARD: EXPERT PRACTICE

DECISION MAKING HEURISTIC: RTS - ANALYSE - RESPOND

APPLY: ANALYTICAL TECHNIQUES

COMPLEXCAUSE-EFFECT PROFILE: NON-LINEAR; DYNAMIC; INTERACTIVE; NON-PREDICTABLE

EPISTEMIC PROFILE: UNKNOWN ‘UNKNOWNS’

STANDARD: EMERGENT PRACTICE

DECISION MAKING HEURISTIC: PROBE - RTS - RESPOND

APPLY: PROBING & HERMENEUTIC TECHNIQUES

NOTE: RTS = read the signals

Thank you again.

Hope you found it of interest.