Financial lessons from nature

“Systems thinking”, the growth of complexity and requirements for

resilience

Fractal [self similar] systemsAdaptive cycles are the foundation of both natural ecological and human socio-economic systems, and have been investigated independently from very different perspectives by ecologists and financial analysts who, until some “thought leadership” from the highest levels within Bank of England, had almost certainly never collaborated. It is interesting then to look at the strong correspondence of the self-similar hierarchical patterns, best described as fractals, which emerge from both fields. This form of organisation seems to be a fundamental dynamic in many areas.

Growth phaseDuring the growth phase the system finds an abundance of resources available. Expansion and exploration of new opportunities are key concepts within this stage. “When new ecological spaces open up – due, for instance, to forest fires, or retreating glaciers, or many other things- resources needed for other species to grow are made available. There’s more light reaching the soil surface when large trees are toppled, or burned to the ground, for example.”

Conservation [consolidation) phase“The "r" phase is transitory, and as the system matures, it is replaced by the K phase. Eventually slower growing, long lived species or entities enter the system. Resources become less widely available as they become “locked up”… The K phase is sometimes called the conservation phase, because energy acquired goes into maintaining or conserving existing structure, rather than building new structure. In this phase, a few dominant species or companies or countries … have acquired many of the resources and are controlling the way they can be used.”

Release phase“Often systems rapidly pass into a phase called omega. This is also referred to as the release (or creative destruction) phase because structure, relationships, capital or complexity accumulated during the r and K phases is released (often in a dramatic or abrupt fashion). … Plants may die … or a company may go bankrupt, releasing workers and decommissioning factories or offices.”

Reorganisation phase“The fourth, or alpha phase, is a period of reorganisation, in which some of the entities previously released begin to re-structure but not necessarily as they were before. This phase can mark the beginning of another trip through an adaptive cycle … Many new entities may enter the system, and innovation becomes more probable.”

Nested adaptive cycles: in nature and economy Adaptive cycles do not exist in isolation. Local ecosystem cycles are embedded in larger and slower-moving regional cycles operating over years and decades, which are in turn part of global climate and elemental cycles (carbon, nitrogen, phosphorus etc.) that may unfold over centuries or millennia. These larger cycles can act as stabilising factors by adding a 'memory effect', or wealth reservoir, enabling rapid regeneration following a localized setback, but only if the larger cycle is not in its own contraction and reorganisation phase. In addition to being part of larger cycles, dynamic ecosystems are also composed of smaller and faster-moving cycles of growth and decay, operating on much shorter time horizons. This nested set of self-similar structures allows for both persistence and innovation.

"We had the complete collapse of a model based on consumer spending, a housing bubble, an overweight banking system - three banks, each of them with a balance sheet larger than the British economy.

"It was a disaster waiting to happen and it did happen. It has done profound damage and it is damage that is going to last a long time."

Vince Cable, Business Secretary

The “butterfly effect” and the nature of systemic risk

Collapse, if and when it comes again, will this time be global. No longer can any individual nation collapse. World civilization will disintegrate as a whole. Competitors who evolve as peers collapse in like manner. J Tainter

We have become very accomplished at assessing and managing many risks i.e. the potential for losses arising from events that we have past experience of. But our lack of experience in dealing with the “emerging risks” and uncertainties of non-linear systems has already been demonstrated by the collapse of global banking and a succession of natural disasters.The ability to apply lessons learnt, from the behaviour of complex natural systems to the, Globally inter-connected, dynamic [non-linear] business systems now exists .Our awareness of the nature and cost of “low probability, high impact “[Black Swan] events illustrate the need to build resilient systems and networks that rely upon inter-connectedness for their survival. Otherwise the characteristics of fragile, self-similar, systems are communicated [butterfly effect] to those connected to it …failure can lead to sudden collapse across domains…

"It is not the strongest of the species that survive, nor the most intelligent, but the one most responsive to change."

Charles Darwin

The complexity of inter-connectedness can be plainly seen in every area of modern life – this map shows UK internet density. But interdependence is a feature of the most successful and resilient systems: ecological; biological; societal; economic. Inter-connectedness is the conduit for risk and uncertainty that are generated and communicated among systems and across networks.We define resilience, formally, as the capacity of a system to absorb disturbance and reorganise while undergoing change so as to still retain essentially the same function, structure and feedbacks - and therefore the same “functionality”.

Resilience: amid growing complexity

Assessing the health of a business system [SME]“Imagine assessing the robustness of the electricity grid with data on power stations but not on the power lines connecting them”

But that is, essentially, what we do by sampling the type of information used for Accounting purposes - shown (right).It serves as a means to benchmark against past or peer performance – although data can be 12 (or more) months old and is subject to manipulation to achieve a specific outcome – but fails to inform as to the “health” of the system……vital information for:a company ownera firm involved in “risk transfer”suppliers or customersestablishing a resilient economy!

Characteristics of a Highly Complex Business or System

Difficult to manage

Highly exposedVulnerable

Unhealthy

Unsustainable

Fragile

What’s in a name – a logo – a brand?…what goes around comes around

Complexity

Creator

casualty

You don’t have to be BIG, bent, bad at business or just plain greedy to get things wrong or to suffer from unforeseen circumstances …ALTHOUGH it doesn’t help!

It hurts. Many people have suffered and will continue to do so for some time but…

what have WE learnt?

what have THEY learnt?

what chance real CHANGE?

what price TRANSPARENCY?

…the dynamic systems of the new modernity are non-linear and, therefore, IMPOSSIBLE to measure and manage utilising conventional tools.

Creator User

SYSTEM owners are accountable to STAKEHOLDERS across the ECOSYSTEM, including supply chain PARTNERS and inter-connected NETWORKS . SHARING the responsibility to deliver SUSTAINABLE CUSTOMER VALUE. TRANSPARENCY is the foundation for the TRUST required for a truly INTERDEPENDENT system.

Ontonix UK

• Contact:– David G Wilson, CEO– m. + 44 (0) 7919 917150– e. david@ontonix.com– w. www.ontonix.com

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Ontonix UK Ltd. Registered number: SC380992. Registered office: The C'a'doro, 45 Gordon Street, Glasgow, G1 3PE

Credit: Much of the inspiration and content for this presentation came from the analysis of Buzz Hollings’ work by: http://theautomaticearth.blogspot.com