significant risk governance issues? Or, should it be the chairman who must be capable of grasping and driving sustainability management parameters proactively?
Each board needs to address this question, weighing all options along with their pros and cons. Such deliberations constitute the starting point for developing the organization focus for effective sustainability management and bringing about a fundamental change to enhance the ability to survive extreme crises.
18.1.2. What Should Parameters Focus on?
No dialog can begin or take place in a vacuum; it needs an appropriate context. Therefore, before the dialog about objectives and goals begins, there must be an understanding of the structure that causes the need for the sustainability objective and goals in the first place. This requires a way to quantify and express the extreme tail-risk structure. As emphasized early on in this book, to date there is no objective, transparent, and simple measure to quantify exposure from extreme tail risk. This book has offered PML and demonstrated its power as an effective quantitative measure of extreme risk.
Therefore, the PML of the institution—along the lines of the examples discussed previously—needs to be developed to provide the context for the dialog to establish sustainability-management parameters. This includes knowing the total magnitude of PML and fully understanding what makes up PML and how different businesses impact PML in different ways.
Understanding PML and its components is the second key step in adapt¬ing an organization to effective sustainability management, as it helps iden-tify what constitutes the exposure from extreme tail risk and thus what should be addressed.
18.1.3. How Should Parameters Be Established?
Having gained a good understanding of the institution’s PML and its com¬ponents, the next step is to establish sustainability parameters. This starts with a discussion of what should be the sustainability objective of the insti¬tution and should involve the entire board of directors.
Establishing parameters means defining boundaries and guidelines, which are determined by goals. Since there is a trade-off between financial goals and sustainability goals, it is essential to understand this relationship so that corporate goals maximize the financial potential of the institution’s business model while ensuring protection against extreme tail risk. Discus¬sions of this trade-off will lead to goals that can drive the sustainability-management process of the institution.
Sustainability goals help drive the boundaries and policies, or parame¬ters, which requires addressing sustainability-management issues, such as:
• What size and scope of extreme exposure parameters are acceptable?
• What will be the impact of sustainability-management goals?
• What adjustments are needed to ensure compliance with these goals?
• How much protection should be provided?
• What guidelines should drive programs to protect against extreme tail risk?
• What criteria should be used to establish an extreme exposure limit for each business segment? And, what should be the limits for each business segment?
Such issues require significant quantitative financial analyses, and addressing them will lead to an implementation roadmap for the institution.
18.2. IMPLEMENTATION
Having established the parameters, an implementation plan needs to be developed that (i) designs and creates strategies and policies to optimize cost-benefit trade-offs in managing PML and sustainability gaps within the established parameters and (ii) ensures compliance and control mech¬anisms. While a distinct focus is needed, the sustainability-management process can’t exist as an island. It impacts financial- and risk-management functions of the institution. Therefore, bridges must be developed between sustainability parameters and other operating guidelines for the institution.
18.2.1. Incremental, not Replacement
Chapter 3 discussed the objectives of risk management, capital manage¬ment, and sustainability