Enterprise Risk Management

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Enterprise Risk Management

• Dr. Jacques Saint-Pierre, LABVAL
• From a process of compliance
• to a strategic tool
• for value creation

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Value Creation landscape

• The new, holistic view of risk realizes the goal
  is value creation.
• Risk management, capital structure management,
  and capital budgeting, if coordinated
  effectively, provide a framework to decrease
  total risk while increasing future expected cash
  flow.

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Capital Structure Management (1/2)

• The highest credit rating is not a sufficient
  condition to maximise value creation.
• Depending on the portfolio of existing assets and
  liabilities (business mix), the marginal cost of
  maintaining the highest credit rating can be
  greater than the benefits it provides.

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Capital Structure Management (2/2)

• Once a bond-rating objective has been determined,
  the question becomes how much debt a company can
  borrow.
• The optimal capital structure trade-off simply
  cannot be properly evaluated in terms of an
  effect on the interest paid on one of the
  components of capital.

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Capital Management

• Firms wishing to obtain sustainable superior
  returns cannot avoid committing to at least some
  firm-specific resources.
• Commitments to firm-specific resources are no
  panacea because they may imply irreversible
  losses as well as sustainable superior returns.
• Most of the strategic choices that managers have
  to make in todays highly uncertain and
  competitive markets imply both commitment and
  flexibility.

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Developing a culture

• that integrates risk management into the
  decision-making process is often the first step
  in reaping rewards from ERM in terms of value
  creation.

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Do not let regulators drive

• tomorrows risk management agenda.
• Meet regulatory demands but ensure your
  decision-making process is seen both company wide
  and by shareholders as a single entity working
  toward value creation.

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Remember W. Edwards Deming (1900-1993)

• What we need to do is learn to work in the
  system, by which I mean that everybody, every
  team, every platform, every division, every
  component is there not for individual competitive
  profit or recognition, but for contribution to
  the system as a whole on a win-win basis.

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RatingsDirect

• ERM For Ratings Of Nonfinancial Corporations

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On May 7, 2008, Standard Poor's Ratings
Services announced that they would expand their
ratings analysis of nonfinancial corporations to
include a review of enterprise risk management
(ERM). They expect this initiative to enhance
their analysis of management generally, identify
differentiated capabilities of companies to
respond to adversity, and help make their ratings
more forward-looking.
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Which sectors would get an ERM analysis?

• SPs will introduce ERM discussions into the
  ratings process for all companies in all sectors
  globally. Roll-out will be staggered over several
  months.

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Exactly when will this happen?

• ERM will become a part of the standing agenda in
  regular review meetings SPs have with rated
  companies beginning in the third quarter of 2008.
  After three to six months of gathering
  information from these discussions, they expect
  to be able to benchmark ERM performance and
  publish criteria that will eventually lead to
  evaluation and possible scoring of ERM
  capabilities. They would not expect to entertain
  the idea of scoring until at least mid-2009.

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What if companies want to present their ERM
before their regular review meeting?

• They are open to discussing ERM with companies at
  any time, but for SPs a more effective
  discussion will result from allowing their
  analysts to take the lead in scheduling.
• SP does not require elaborate ERM presentations
  because they say their analysts are already
  familiar with companies' key risks, risk
  appetite, and risk-mitigation strategies.
• According to SPs the ERM discussion fits
  naturally into the existing dialogues they
  routinely conduct. Always according to SPs,
  good risk-management practice suggests that ERM
  be integrated into everyday practice and
  therefore not be something that requires hours of
  explanation.

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Who will conduct the reviews?

• The primary ratings analyst for each company has
  responsibility for the review. ERM specialists
  will assist with training and consistency issues.
  In all cases, someone who is knowledgeable about
  the sector will do the review.

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What effect will ERM have on ratings in the long
run?

• SPs will use ERM analysis to enhance their
  evaluation of management performance, an existing
  part of their analytical framework. They expect
  that the effect on ratings will be on the
  margins firms with very highly developed ERM
  programs might see a positive impact on the
  ratings and firms with unexpectedly poor ERM
  programs might see a negative impact.

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Discussion Questions for Management Meetings
SPs ERM review for nonfinancial companies will
be based primarily on information provided by
issuers in public disclosures and through
discussions with SP analysts. The following
slide provides sample discussion topics and
questions about which their analysts will inquire.
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Sample Discussion Topics and Questions

1. What are the company's top risks, how big are
   they, and how often are they likely to occur? How
   often is the list of top risks updated?
2. What is management doing about top risks?
3. What size quarterly operating or cash loss has
   management and the board agreed is tolerable?
4. Describe the staff responsible for risk
   management programs and their place in the
   organization chart. How do you measure success of
   risk management activities?
5. How would a loss from a key risk impact incentive
   compensation of top management and on
   planning/budgeting?
6. Tell us about discussions about risk management
   that have taken place at the board level or among
   top management when making strategic decisions.
7. Give an example of how your company responded to
   a recent surprise in your industry and describe
   whether the surprise affected your company and
   others differently.

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How to prepare your company ?
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Q How can your company prepare for the ERM
discussion and ratings process with SPs?

• A The ERM evaluation is an opportunity to
  establish a comfort level with the ratings agency
  as it adds a new dimension to its assessment of
  enterprise stability and the readiness of your
  own risk management capability.
• Management can prepare by
• Leveraging work already done on ERM.
• Performing a robust risk assessment that goes
  beyond business-as- usual and
  includes emerging risks.
• Evaluating, and being able to articulate, the
  inherent strengths and weaknesses of the current
  ERM capability.
• Assessing the state of the companys risk
  management culture.
• Demonstrating that ERM influences strategic
  planning.
• Preparing an action plan to improve the SP ERM
  rating, secure an upgrade or defend against a
  downgrade.
• Developing a presentation that demonstrates ERM
  progress to SP.

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Q What is the boards role?
A Boards must first recognize the SPs
pronouncement is meaningful in that a direct
relationship is being established between ERM
assessments and credit rating decisions. Boards
can begin by seeking assurance from management
that an effective ERM framework is in place and
that management is prepared to champion the
current ERM environment to the rating agency.
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Q How are the scores defined and when will they
be applied?
A The ERM scores will be presented in four
levels excellent (lowest risk), strong (slight
risk), adequate (moderate risk) and weak (highest
risk). SPs has said that formal scoring of ERM
capabilities will be deferred until the agency
has conducted a sufficient number of reviews
across sectors to permit reliable benchmarking
and publishing of evaluation criteria. This could
be well into 2009.
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Sources

• www.algorithmics.com
• www.standardandpoors.com