Bank of Montreal 2013 Annual Report Download - page 85

MANAGEMENT’S DISCUSSION AND ANALYSIS
delegated to the boards of the insurance subsidiaries, or that expose risks facing the insurance subsidiaries, which include top-line and
BMO to significant risk. emerging risks, as well as key risk indicators. A comprehensive risk
Our insurance subsidiaries provide independent evaluation and review process is in place to identify the key risks associated with
reporting of risk exposures to their boards of directors and at the enter- insurance operations and products, as well as the controls required for
prise level, including reporting to both management of Wealth risk mitigation.
Management and the RRC. Reporting involves an assessment of all
MD&A
Legal and Regulatory Risk
Legal and regulatory risk is the risk of not complying with laws,
contractual undertakings or other legal requirements, as well as
regulatory requirements and regulators’ expectations. Failure to
properly manage legal and regulatory risk may result in litigation,
financial losses, regulatory sanctions, an inability to execute our
business strategies and harm to our reputation.
BMO’s success also relies on our ability to manage prudently our
exposure to judgments, fines or losses arising from the risk of not
complying with laws, contractual undertakings, or meeting regulatory
requirements or regulator expectations. Fiduciary risk relating to BMO’s
businesses providing products or services that give rise to fiduciary
duties to clients is another area of focus for legal and compliance
management and operating groups’ risk committees. Of particular
importance are the policies and practices that address a business’
responsibilities to a client, including service requirements and expect-
ations, client suitability determinations, and disclosure obligations and
communications. Failure to properly manage these risks may result in
harm to our reputation, cause a decline in investor confidence, and
affect our ability to execute our business strategies.
Under the direction of the General Counsel, Legal and Compliance
Group (LCG) maintains enterprise-wide frameworks to identify, measure,
manage, monitor and report on legal (including fiduciary) and regulatory
risk. These frameworks reflect the three lines-of-defence operating
model described previously. The operating groups and Corporate Support
areas must manage day-to-day risks in compliance with policies while
LCG teams specifically aligned to designated operating groups provide
advice and independent legal and regulatory risk management oversight.
LCG also works with operating groups and Corporate Support areas to
identify legal and regulatory requirements and potential risks, recom-
mend mitigation strategies and actions, and oversee litigation
involving BMO.
The General Counsel and Chief Compliance Officer (CCO) regularly
report to the Audit and Conduct Review Committee of the board and to
senior management on the effectiveness of our Enterprise Compliance
Program (ECP) which, using a risk-based approach, identifies, assesses
and manages legal and regulatory requirements. The ECP requires that
operating groups and Corporate Support areas maintain compliance
policies, procedures and controls to meet these requirements. Under the
direction of the CCO, LCG identifies gaps and deficiencies and tracks
remedial action plans.
BMO’s code of conduct, FirstPrinciples, outlines our commitment to
high standards of ethics and integrity, and requires that each employee
take responsibility to follow both the letter and the spirit of the law. All
directors and employees annually acknowledge their commitment to
FirstPrinciples, and take required training that tests their knowledge and
understanding of the code. This annual training also includes other
important legal and regulatory subjects, including anti-money launder-
ing, privacy and anti-corruption practices.
The financial services industry is highly regulated and continues to
receive heightened attention under worldwide regulatory reform ini-
tiatives. BMO has experienced a significant increase in regulation and
supervision, and such changes could have a significant impact on how
we conduct business. LCG continues to work diligently in assessing and
understanding the implications of these regulatory changes, and devotes
substantial resources to implementing new regulations while helping the
operating groups meet the needs and demands of BMO’s clients.
Business Risk
Business risk arises from the specific business activities of a
company and the effects these could have on its earnings.
Business risk encompasses the potential causes of earnings volatility
that are distinct from credit, market or operational risk factors. The
management of business risk identifies and addresses factors related
to the risk that volumes will decrease or margins will shrink without
the company having the ability to compensate for this decline by
cutting costs.
BMO faces many risks that are similar to those faced by non-
financial firms, principally that our profitability, and hence value, may be
eroded by changes in the business environment or by failures of
strategy or execution. Sources of these risks include, but are not limited
to, changing client expectations, adverse business developments and
relatively ineffective responses to industry changes.
Within BMO, each operating group is responsible for controlling its
respective business risk by assessing, managing and mitigating the risks
arising from changes in business volumes and cost structures, among
other factors.
Model Risk
Model risk is the potential for loss due to the risk that a model may
not perform or capture risk as designed. It also arises from the
possibility of the use of an inappropriate model or the inappropriate
use of a model.
BMO uses models that range from the very simple to those that value
complex transactions or involve sophisticated portfolio and capital
management methodologies. These models are used to inform strategic
decision-making and to assist in making daily lending, trading, under-
96 BMO Financial Group 196th Annual Report 2013
writing, funding, investment and operational decisions. Models have also
been developed to measure exposure to specific risks and to measure total
risk on an integrated basis, using Economic Capital. We have strong controls
over the development, implementation and application of these models.
BMO uses a variety of models, which can be grouped within
six categories:
‰ valuation models for the valuation of assets, liabilities or reserves;
‰ risk exposure models for measuring credit risk, market risk, liquidity
risk and operational risk, which also address expected loss and
its applications;