Top Risk Management Concerns

This was apparently a survey done by the Conference Board that highlights the top 5 concerns among executives world-wide and I find similarities in listing our top concerns as we assessed the impact of the financial crisis to this organization culminating in our common concerns across all businesses :

1. Economic slowdown


2. Project/CAPEX spending


3. Customer


4. Supplier


5. Financial (which includes liquidity, counter-party, FX and interest rate risks)

The Year 2008 for FRM

It has been a busy year for all of us here in this division and nonetheless, for the FRM team. The FRM team has, against all odds,

• multitasked
• managed projects
• coordinating cross-departmental analysis
• responding quickly to demanding clients
• responding to the financial crisis
• co-operated in divisional initiatives in good spirits
• asserting their opinions where they have to, having a firm stand on principles, taking the lead in initiatives and tasks, taking the lead in discussions

achieving many incremental steps and giant leaps that makes me proud to have had the opportunity to work with you and learn from you in that process.

The year 2008 is also the year where we welcomed new members to FRM : Ghaf, Fiza, Nabil, Emylia, Eyna and Maheran. Your learning curve has been steep, I know, but you are all achievers and you bravely responded to all the challenges that a new organization brings about.

This year we also saw team members leave for the better : Wis2 to TBS, Idah to A&O, Tris to FI and Rita to Group Risk. I thank you for your contributions to FRM and I hope the FRM experience will be of value to you throughout your career, wherever that may be in future.

Which leaves the old timers, Haslina, Ray2, and Seed (even though Ray2 and Seed to their benefit is not as old a timer as Haslina) : How can I describe you? Steadfast, guardian, mentor, guiding and coaching, persistent, challenge the conventional, thought partners to your colleagues, you have been there for the new team members and you held your own, too, with the work stuff that lands on your desk from within and externally.

Thank you to Elie for your unwavering support to me and the team. Thank you.

So with that I leave you these quotes :

For new team members :

Coming together is a beginning. Keeping together is progress. Working together is success.

For those who have left us :

You are what you think. You are what you go for. You are what you do!

And for Haslina, Ray2 and Seed :

A difficult time can be more readily endured if we retain the conviction that our existence holds a purpose - a cause to pursue, a person to love, a goal to achieve.

And to all,

A true measure of your worth includes all the benefits others have gained from your success.

I certainly have gained experience and knowledge from the FRM team's achievements especially this year where it has been challenging for all of us!

Happy New Year and happy year end holidays to all!

Looking beyond models

This article serves my point that fixation with risk models and complacency with having these models is dangerous and the results from risk models must be applied in the right context and combined with good, common sense judgement.

From the CROForum

Excerpts from http://www.croforum.org/home.ecp

What has been learnt in the light of the crisis

A good deal of the pre-crisis discussion went around the details of risk modelling. If there is one thing the crisis reinforces, it is: Risk management is much more than models. The CRO Forum believes that risk models are indispensible for managing the business.
However the risk models must be – and in many cases are already – complemented with Internal Controls, such as risk concentration limits on a notional gross and net basis, Probable Maximum Loss (PML) limits, or stress and scenario testing. Finally, there is no substitute for a deep understanding of the risks involved in the business – and for common sense.

Every crisis of this dimension is associated with fundamental changes of business
models and hence implies changes of basic parameters. Parameter values, e.g. default
probabilities and equity market stresses, which have been estimated from pre-crisis times may no longer be adequate during and maybe even after the crisis. Risk management isjust as much about preparing for what has not happened as it is for understanding and preparing for what has been experienced in the past. Stress tests and scenario planning can address the problems related to system change.


Given the huge market value losses in certain financial institutions, the CRO Forum
believes that Risk Management must be viewed as an investment into the company's
future rather than simply as a cost factor. We expect to see management and regulators
seeking to further strengthen ERM functions, resulting in growing powers and
responsibilities of CROs and their teams. Given the role of risk management as second
line of defence after line management, it is important that risk teams have the freedom
and the capability to take an independent view from business management. A word of
caution here: independence does by no means imply ignorance. We are firmly convinced that both operating units and risk management functions need a deep understanding of the business. Independence has to be supplemented by mutual understanding and respect. Hence risk management will increasingly become an integral part of the business.

Managing in the Downturn : Boosting liquidity

Summary of the Economist article

Drivers

• Faced with huge difficulties of their own, banks have tightened their purse strings, lending less and driving up the cost of credit to consumers and corporations.
• Opinions differ as to how long and deep the global slowdown might be. But the combination of a battered banking system and shell-shocked consumers mired in debt suggests it could be particularly hard for many businesses, whatever the duration.
• For the foreseeable future, bank credit is likely to be harder to come by and will certainly be more expensive than when the financial crisis began.

Cash boosting strategy

• Companies have tapped new pools of capital, like sovereign-wealth funds, to bolster their finances. In July GE, an American conglomerate, set up an $8 billion, 50-50 joint venture with Mubadala, an investment arm of Abu Dhabi, to invest in areas such as clean energy and aviation.
• Sell businesses no longer central to a firm’s strategy. Although prices for corporate assets have been depressed by the downturn, this has not deterred some companies from putting them up for auction. This week, for instance, GM and Ford sold shares in Suzuki and Mazda respectively. By selling their stakes back to the Japanese firms, the American carmakers raised a total of $770m of badly needed liquidity.
• Letting less cash go out of the door. Several big companies including Alcoa, an American aluminium giant, Target, an American discount retailer, and AkzoNobel, a Dutch firm that makes paint and specialty chemicals, have recently cancelled plans to buy back shares using what was previously viewed as excess cash. Companies are starting to trim dividends too, though this will be unpopular with investors expecting a regular stream of income.
• Stretching out the payments on bank debt can also preserve cash. And firms should look out for opportunities to refinance existing loans early to give themselves greater financial flexibility.
• Put under the microscope a company's working capital, or the cash that gets tied up in day-to-day operations. “The first place to look for this money is in a firm’s inventory,” says Wayne Mincey, Hackett’s chief operating officer. All too often, poor sales forecasting and production planning mean that a lot of cash ends up trapped in a company’s warehouses in the form of unwanted products.

Oil and Gas News

Petrobras Bullish on Outlook for New Fields
http://www.ft.com/cms/s/0/00aa90ae-c7a6-11dd-b611-000077b07658.html

ExxonMobil to Invest in Refinery Expansion
http://www.ft.com/cms/s/0/27f2a81c-cb12-11dd-87d7-000077b07658.html

BP's Hopes for China Oil Growth
http://www.ft.com/cms/s/0/7646930e-c728-11dd-97a5-000077b07658.html

Reduced oil spending

From the plains of North Dakota to the deep waters of Brazil, dozens of major oil and gas projects have been suspended or canceled in recent weeks as companies scramble to adjust to the collapse in energy markets.

In the short run, falling oil prices are leading to welcome relief at the pump for American families ahead of the holidays, with gasoline down from its summer record of just over $4 to an average of $1.66 a gallon, and still falling.

But the project delays are likely to reduce future energy supplies — and analysts believe they may set the stage for another surge in oil prices once the global economy recovers.
Oil markets have had their sharpest-ever spikes and their steepest drops this year, all within a few months. Now, with a global recession at hand and oil consumption falling, the market’s extreme volatility is making it harder for energy executives to plan ahead. As a result, exploration spending, which had risen to a record this year, is being slashed.

The precipitous drop in oil prices since the summer, coming on the heels of a dizzying seven-year rise, was a reminder that the oil business, like those of most commodities, is cyclical. When demand drops and prices fall, companies curb their investments, leading to lower supplies. When demand recovers, prices rise again and companies start to invest in new production, starting another cycle.

As familiar as the pattern may be, the changes this time are taking place at record speed. In June, some analysts were forecasting oil at $200 a barrel and companies were scouring the earth for new places to drill; now, no one knows how low prices may fall.

“It’s a classic — if extraordinarily dramatic — cycle,” said Daniel Yergin, chairman of Cambridge Energy Research Associates and author of “The Prize,” a history of the oil business. “Prices have come down so far and so fast, it’s become a shock to the supply system.”

The list of projects delayed is growing by the week. Wells are being shut down across the United States; new refineries have been postponed in Saudi Arabia, Kuwait and India; and ambitious plans for drilling off the coast of Africa are being reconsidered.

Investment in alternative energy sources like biofuels that had flourished in recent years could dry up if prices stay low for the next few years, analysts said. Banks have become reluctant lenders, especially to renewable energy projects that may prove unprofitable in an era of low oil and gas prices.
These delays could curb future global fuel supplies by the equivalent of four million barrels a day within the next five years, according to Peter Jackson, an energy analyst at Cambridge Energy Research Associates. That is equal to 5 percent of current oil supplies.

One reason projects are being shut down so fast is that costs throughout the industry, which had surged in recent years, are still elevated despite the drop in oil prices. Many companies are waiting for those costs to come down before deciding whether to go forward with new projects.
“The global market has been turned upside down since the summer,” the International Energy Agency, a leading energy forecaster, said in a recent report.

In today’s uncertain environment, a slowdown in spending is inevitable, according to energy executives who are devising their budgets for next year. Last year, spending on exploration and production amounted to $329 billion, according to PFC Energy, a consulting firm. That figure is certain to fall.

“We’re in remission right now,” said Marvin E. Odum, the vice president for exploration and production for Royal Dutch Shell in the Americas. But once the economy picks up, he said, “the energy challenge will come back with a vengeance.”

Oil demand growth has weakened throughout the industrial world. The International Energy Agency projects that worldwide demand will actually fall this year, for the first time since 1983.
So much surplus oil is sloshing around the world right now that some companies, including Shell, are using oil tankers for storage.

Oil prices have declined by more than $100 a barrel since July, returning to levels last seen more than four years ago. They settled at $44.51 a barrel, down $1.77, on Monday in New York, as concerns about the economy outweighed efforts by oil producers to stem the slide in prices.
Prices could drop below $30 a barrel, according to Merrill Lynch and other forecasters, if the Chinese economy slows drastically next year, which looks increasingly likely.

Different companies have different price thresholds for going forward with drilling projects. But across the industry, a price drop this big has “a dampening effect,” according to Mr. Odum of Shell. “The big uncertainty is how long this economic environment is going to last.”

The biggest cutbacks so far have been in heavy oil projects in Canada, where some of the world’s highest-cost production is concentrated. Some operators there need oil prices above $90 a barrel to turn a profit.

StatoilHydro, a large Norwegian company, recently pulled out of a $12 billion project in Canada because of falling prices. Similarly, Shell, Nexen and Petro-Canada have all canceled or postponed new ventures in the province of Alberta in recent weeks.

Producers are bracing for a painful contraction, and the drop in prices could crimp investments even in places where production costs are low.

The Saudi monarch, King Abdullah, recently said he considered $75 a barrel to be a “fair price.” The kingdom, which has invested tens of billions of dollars in recent years to increase production, recently announced that two new refineries, with ConocoPhillips and Total of France, were being frozen until costs go down.

In neighboring Kuwait, the government recently shelved a $15 billion project to build the country’s fourth refinery because of concerns about slowing growth in oil demand.

The list goes on:

• South Africa’s national oil company, PetroSA, on Thursday dropped plans to build a plant that would have converted coal to liquid fuel.
• The British-Russian giant TNK-BP slashed its capital expenditure budget for next year by $1 billion, for a 25 percent reduction from this year.
• In North Dakota, oil drillers are scaling back exploration of the Bakken Shale, a geological formation recently seen as promising, where production is more expensive than in conventional fields.
  “People are dropping rigs up there in a pretty significant way already,” Mark G. Papa, the chief executive of EOG Resources, a small natural gas producer, recently told an energy conference.
• Another domestic producer, Callon Petroleum, suspended a major deepwater project in the Gulf of Mexico, called Entrada, weeks before completion because of what it described as a “serious decline in project economics.”
  According to research analysts at the brokerage firm Raymond James, domestic drilling could drop by 41 percent next year as companies scale back.

“We expect operators to significantly cut their activity in the coming weeks due to the holiday season, and many of these rigs will not come back to work,” the report said.

As scores of small wells are shut down, analysts at Bernstein Research have calculated that oil production in North America could decline by 1.3 million barrels a day through 2010, or 17 percent, to 6.14 million barrels a day. This decline, rather than cuts by members of the Organization of the Petroleum Exporting Countries, “will be the catalyst needed for oil prices to rebound,” Neil McMahon, an analyst at Bernstein Research, said in a conference call this month. The United States remains the world’s largest oil consumer.

The drop in energy consumption could afford some breathing room for producers, which had been straining in recent years to match fast-rising demand. But analysts warn the world can ill afford a lengthy drop in investment in energy supplies. To meet the growth in global population and the rising affluence expected in the future, the world will need to invest $12 trillion in order to increase its oil and natural gas supplies, according to the International Energy Agency.
“If we cut back dramatically on investments, we could end up in a situation where supply growth goes flat when the economy starts to recover,” said Mr. Jackson, the analyst. “The steeper the decline, the steeper the response.”

Risk Roundtable : Rethinking Risk Management

The success (or even failure) of risk management in this organization really does depend on the specific situations in the company with its specific histories, cultures and management.

Being involved in numerous risk management efforts, discussions and debates throughout the organization, in a an advisory capacity or as a risk management practitioner, there seems to be a continuing gap in major areas of :

• what expectations are on the promise of risk management (integrated or ERM)


• the understanding of what risk management is all about


• the spectrum of risks that an organization faces


• the guidance amd directives in managing risks


• the roles and responsibilities in risk management


• the tools that are used to identify, assess and control risks
  

I am sure there are more areas than those that I have listed above. I believe these are the broad areas and anything else would probably form as a sub-category under any one of the above.

This gap has been evident through the feedback from our clients (subsidiaries), the satisfaction (or dissatisfaction) levels on expectations of risk management, risk management practitioners sense of what people's perception risk management is and what is actually happening on the ground, and more importantly in my view, the ability (or inability) to respond quickly, decisively to situations triggered by events that adversely impacts the organization.

To be able to close this gap, in considering the legacy of risk management in this organization, I believe the following steps are imperative :

• Being honest with ourselves on the state of risk management in the organization today and where we want it to be
  
  What were the successes and failures of the past? Leverage on successes, do not repeat the mistakes that led to failures.
  

What is the greatest complaint on risk management? This is to get the change perspective in risk management

What does strong risk management look like? Is there anywhere in the organization that we can see strong risk management already in existence? Can we leverage on that strength rather than re-inventing the risk management wheel? What measures do we use to define success in risk management?

How strong do you want risk management to be? Which relates to what is the tone from the top on risk management? How much weight and importance should risk management have in this organization?

What is risk management now? Is risk management a defense, or both offense and defense, compliance or coordination and integration?

• The answer to all of the above should help in setting a clear vision of what risk management should be in this organization. Without going into specifics, the vision for risk management should be "Integration of Risk in Decision-Making" with the mission being "Changing the Perpectives of Risk Management in the Organization"




• How should risk management change?

1

From Risk management treated as a check in the box i.e. completed list of things to do, risk management seen as a compliance againts rules
To Risk management is about understanding key risk drivers in decision-making and evaluating the impact of market risks onto these drivers and how this will change business decision
Risk helps robust decision-making
2
From Risk management is about reporting
To Ability to see the totality of risks will enable risk return trade off, assess marginal impact of risk decision-making, and direct targeted risk intervention by top level risk oversight function
“Risk of the whole is greater than sum of the parts”
3
From Risk assessment or risk profiling
To Risk management is excellence in execution, controls and the speed, flexibility and adaptability to change.
Confidence in risk exposures and the extent of mitigation in place
4
From Risk management is the job of risk managers
To Risk management is no different than any other business activity
Risk management and business strategy is inextricably linked and integrated in the business value chain.

To be continued

Oil Outlook : From USD200/bbl to USD30/bbl

Remember this piece of news? Where is the prespoterousness in this report now?

Now Goldman is predicting oil price to fall to USD30/bbl in the next three months.

Analyst warns of $200 crude oil
By Javier Blas and Chris Flood in London
Published: May 7 2008 03:00 Last updated: May 7 2008 03:00

Crude oil prices could surge to $200 a barrel in the next two years, according to theGoldman Sachs analyst who three years ago correctly predicted a price "super-spike" above $100 a barrel.

The warning by Arjun Murti came as oil prices hit a fresh record high above $122 a barrel, boosted by supply disruptions in Nigeria, lower output in Russia and continued robust demand in China ahead of the Olympics.

Mr Murti said the energy crisis could be coming to a head as a lack of adequate supply growth was becoming apparent.

"The possibility of $150-$200 per barrel seems increasingly likely over the next 6-24 months," he added, warning also the spare capacity of the Organisation of the Petroleum Exporting Countries to cushion against unexpected supply shocks was low.

Last month, Chakib Khelil, president of Opec, also warned oil could reach $200 a barrel. The number of oil option contracts betting on oil hitting $200 a barrel in December have tripled since the beginning of the year.

Mr Murti's warnings carry weight in the oil market after he correctly predicted in March 2005 when oil traded at about $55 a barrel that prices could suffer a "super-spike" to $105 a barrel.
The warning in 2005 was criticised as "self-serving" because Goldman Sachs is one of the largest Wall Street investment banks trading oil and it could profit from an increase in prices.

The criticism forced the bank's chief executive at that time - Henry Paulson - to defend the bullish report. Mr Paulson is now US Treasury secretary.

Nauman Barakat, of Macquarie in New York, said: "The report should not be dismissed out of hand as preposterous as Goldman hit it on the head with its original super-spike story."

In New York, West Texas Intermediate crude futures yesterday jumped to a record $122.49 a barrel before settling at $121.84 while, in London, Brent crude futures closed at $120.31 a barrel.

The crude oil futures market signalled a growing belief that $100 a barrel is here to stay, with prices for oil to be delivered up to December 2016 trading above $110 a barrel. Kevin Norrish, of Barclays Capital, said the market was undertaking a "recalibration higher of expectations for long-term equilibrium oil prices".

Goldman said the unrelenting rise in long-dated oil prices was consistent with constrained supply driving demand rationing.

The role of CRO

The Chief Risk Officer (CRO) or Risk Management Director is now an established position in Finnish companies and is responsible for a wide range of tasks, the emphasis of which is moving from property risks to business risks.

The most significant challenge for these professionals is considered to be establishing risk management as an integrated part of the management system and business process. In order to be successful, the CRO must first convince line managers of the importance of risk management. This has to be our mantra.

At the same time as enterprise wide risk management (ERM) has become more common, a new group of professionals – the CRO:s – has evolved. The views and opinions of these professionals and the challenges they have experienced were studied in a research project during the spring of 2007. The research was organized by Ernst & Young in co-operation with the Finnish Risk Management Association. The target group was the risk management professionals working in Finnish companies and associations.The professional background of individual CRO:s varies a lot (figure 1).

This may be due to the relative newness of the position and that risk management in its entirety is quite an extensive area, covering many different sectors.

The risk management professionals who answered the questionnaire represented 15 different educational and experience backgrounds in total. When asked, only 17 % of those who answered stated that their education and experience were specifically connected to risk management. The vast majority, i.e. over 80%, have therefore moved to risk management work from another sector, the most common of which is insurance. The other common backgrounds are corporate safety, accounting and financing.

Risk management seeks security


The objectives that an organisation sets for risk management form an important starting point for the work of a CRO (figure 2). The most common objective that the organisations participating in the research work identified for risk management is “ensuring the achievement of targets”. Three-quarters of those who answered the questionnaire stated that they had set this objective.

Setting objectives is a fundamental part of ERM. According to this, hazards are all those factors that can put the achieving of business targets at risk – no matter which risk class they represent. Other objectives, which have been most commonly set are connected with improving risk awareness and the risk management function within the organisation, loss prevention and securing continuity of business operations.In contrast, the objectives connected to economy and financing, such as reducing the fluctuations in profits or cash flow, or ensuring the achievement of the forecasted profit are only rarely set. Thus the dogmas of business economics and financing do not seem to be applied to any significant degree in practical risk management work.

This is despite the fact that business economics and financing are well represented in the backgrounds of risk management professionals and that risk management directors or CRO:s very often report to the Chief Finance Officer.Chief Risk Officers participate in many activities and must work in several areas of risk in order to meet the objectives. Typical areas of work cover physical as well as intangible risks, technical as well as commercial risks, together with risks that are internal as well as external to the organisation. However, this does not mean that the CRO would be responsible for all of these risks; according to an established model, the Group Risk Management operates primarily as a coordinator and internal consultant for the managers of the business units, who in practise are responsible for the line risk management.Based on the research results, it is clearly more common for the CRO to participate in developing and co-ordinating risk management activities rather than to be completely responsible for the work. According to the survey, property risk management is the area for which the CRO bears most responsibility for developing risk management strategies.

It has been estimated that nowadays property risks occupy most of the time of the CRO (figure 3). Property risks represent the traditional area of risk management, as do health and safety risks, which also demand a substantial portion of the CRO’s time. Furthermore risks related to marketing, client contact, competitors and supply chain management have recently emerged, to broaden the scope of CRO’s area of responsibility.

In the future the emphasis will be on strategic risks. The results of the survey suggest that this trend will be further strengthened in the future. When asking the question; which types of risk the CRO:s will put the most effort into during the next three years, it is clear that the risks connected with marketing, clients contact, competitors, partners and networks are clearly expected to rise above the others.It seems that the focus for risk management work in the future will be concentrated towards the strategic risks of business operations. This is an area in which the CRO:s have not traditionally been involved.

Only a few of those who answered the questionnaire were of the opinion that in the future the focus should be on property risks. It was also considered that the risks connected to health & safety and economic reporting will demand less consideration in the future than is currently the case. However, this does not mean that these risks will disappear. But so much effort has already been put into these risks, that in the future it is anticipated they will demand less consideration, relative to the newly emerging areas of risk.

The main risk management activities for which the CRO:s are responsible include the development of risk management principles, reporting practices and tools and insurance (figure 4). However, only one in four of the CROs are responsible for identifying and assessing risks. The survey indicates that this task belongs primarily to those who are directly responsible for the risk, being typically found within the sphere of the specific business operations management.
However, it would be beneficial if those working in risk management, actually participate in the risk assessment and provide the necessary methods and tools to carry out the process. Thus it is alarming that almost 40 % of those who answered the questionnaire advised that the risk assessments of investments are carried out without the participation of the CRO, although, it is more common for the CRO to participate in due diligence processes.

The challenge is to take risk management to the business operation units. The biggest challenges for CRO:s are in connection with introducing risk management to the organisation (figure 5). As many as 80% of those who answered the questionnaire felt their main challenge was to integrate risk management into the management system and business processes. The second most important challenge the questionnaire highlighted was marketing risk management and proving its benefits to line management and business operation units. One third of those who answered also felt that the maintenance of defined operating methods in the organisation was a significant challenge. These three issues are closely connected to each other.To ensure that the organisation maintains the risk management processes, it is necessary that risk management is integrated into practical management and that the benefits it brings are clear for the business operation units. The selling of risk management to senior management in a company seems however, to be a lesser challenge, only stated by 25% of the participants. Using the words of one of those who answered the questionnaire: “Senior management has already begun to understand the significance of risk management, however, how do we increase the understanding of the next management levels”?

The most significant challenges when communicating with senior management are connected to understanding their expectations, clarifying their targets and meeting their targets, i.e. proving the operating ability of risk management to them and the board of directors.The operating environment of companies is constantly changing and developing and the new phenomena that are emerging in addition to familiar risks must be understood and managed. The world of risk is continuously expanding, so that the challenges facing the Chief Risk Officers will not decrease. On the other hand, the same development might ensure that the services of the CRO in greater and greater demand in the future.

Fredrik Åström, Manager, Advisory Services unit of Ernst & Young

Risk Roundtables : Risk Management of the Future Part 2

What capabilities makes a good risk manager?

Strengthening capabilities in risk management presents us with the

• challenge of determining the risk management skills demanded by the organization now and,
• whether capability development can cope with the new demands of the organization, especially with the globalization of operations and therefore the global nature of risks
  
  Hard skills
  
  
  
• Interpretation of governing policies, regulations and guidelines across all context of risk and business in the organization
• Able to see the bigger picture in risk to the business, having a strategic vision and holistic approach in risk management
• Analytical capabilities and risk quantificationmethodology such as statistical foundation of risk, portfolio management of risks, applying the results of risk quantification in the context of decision-making, developing risk management and mitigation strategies, apply the risk return trade off in assessing and mitigating risks, assessing risks and determining impact across a wide range of businesses in this organization : in summary good understanding of risk concepts, principles and processes
• Able to define risk indicators and report risks
• Enterprise wide and integration risk framework, risk governance and control
• Risk management procedures, assessing risk controls, determining risk control weaknesses and prescribing risk control solutions
• Able to enforce risk management

Soft skills

• Able to communicate on a variety of risk management matters defined in hard skills
• Able to lead discussions on risk, focussing on current risk management matters and providing thought leadership on emerging risk
• Passionate about role in risk management
• Able to demonstrate risk management value proposition in partnering with the business i.e. marketing risk management

To be continued

Risk Roundtables : Risk Management of the Future Part 1

My team and I had the opportunity in participating in a Risk Roundtable Discussion (actual risk roundtable abbreviation not disclosed) recently.

What was really apparent from the 2 1/2 days session was :

• the fact that in a large organization such as this the management of risks is decentralized evidenced by expertise in financial risk, project risk, supply chain risk, plant and facilities risk etc. It is not only the management, it is also the framework, design, approach and implementation that to me seems inconsistent with one another. There were some commonalities, but the actual implementation varies.
• the levels of integration between risks and defining exactly what needs integration seems the proverbial challenge in risk management in this organization
• the focus of the roundtable was to think of what the roundtable could spearhead in progressing risk management in this organization and concluded in the following areas : risk integration, risk capability building, risk governance and risk information infrastructure
• which brings to mind given all of the above, what does enterprise-wide risk management stand for and the value proposition of enterprise-wide risk management

The risk management of the future for this organization has to take into consideration the current developments in risk management across companies and businesses, identify what would be the elements of enterprise risk management and therefore its value proposition and repeat this like a mantra. I know I am talking in circles here, but I know what it takes and what it is, question is, do you?

Risk Assessment Considerations

I found this and thought that this was a good way of depicting the totality in risk assessment that we shoud also have in place.

The burden of risk management

Weighing perils is a heavier burden
By Andrea Felsted

From the financial turmoil to spiralling commodity prices, companies have never faced so many perils. The past few months have seen unprecedented events in financial markets, with a specialist in managing risk through insurance, American International Group, finding itself in crisis because of the risks it had taken insuring complex financial products.

With poor risk management at the heart of many aspects of the financial crisis, what counts as risk is being reassessed. More than a year on from the start of the squeeze on credit, many financial institutions are still aligning their risk management programmes with the new reality.

“In the old world, risk management was potentially a second-order reporting issue. In the new world, it is very likely that [everyone from] the chief executive downwards has to have a greater level of understanding of the real risks and the potential risks that an institution faces,” says Stephen Christie, a partner at Ernst & Young, the professional services firm.

Global financial shocks were high on a list of the top 10 strategic risks for business, second only to regulatory and compliance risks, according to research from E&Y and Oxford Analytica, the strategic consultancy.

Many financial services organisations are still adapting their risk-management programmes to the lessons learned from the crisis. ”Risk management is about continuous learning, because every time there is a crisis you discover new things,” says Raj Singh, chief risk officer at Swiss Re, the reinsurer.

The lessons being learned include understanding and measuring the risks within increasingly complex financial instruments. “The crisis has shown that it is far more complicated to measure risk than we thought previously,” Mr Singh says.

According to Clare Thompson, financial services risk advisory leader at professional services firm PricewaterhouseCoopers, fully taking the lessons onboard could be a lengthy process.
“It is quite a long haul for some organisations to really go back and look, and really understand, the risks they face,” she says.

Werner Grub, a founding partner of Richmond Park Capital, an independent merchant bank that provides risk-management advice, suggests there is a danger of businesses being slowed by excessive caution because of the recent turmoil.

“It is like a stop and go policy. Now we are in the stop phase which leads to a negative attitude, such as banks’ reluctance to lend to each other. There must be a rethinking of risk management, not relying only on quantitative analysis, but also going back to the qualitative, which often people considered as too unsophisticated,” he says.

Outside financial institutions the crisis in credit markets is also being felt, particularly as it mutates into a broader economic downturn.

It is harder for companies to borrow, while they also risk succumbing to the tactics of other companies that may be experiencing strain, such as delaying payments for goods and services.
Many are concentrating on the management of their working capital – the cash a company needs to operate on a day-to-day basis.

“What we are seeing a lot of at the moment is companies focusing on working capital management. Whether that is the creditor/ debtor balance or managing inventory, the common denominator is that companies are applying this to the decisions they make,” says Hans-Kristian Bryn, a partner at Oliver Wyman, the consultancy.
Companies are also turning their attentions to the hazards from a broader economic downturn – from an increased risk of being the victim of theft or fraud, to the impact on their balance sheets or pension funds from wild swings in equity markets.

Corporations are also having to cope with escalating commodity prices, although there has been some respite from this over recent weeks.

Sean Mulhearn, global co-head of commodities at Standard Chartered, the bank, says: “Almost all commodities have seen dramatic price increases over the past several years. We have also seen significant increases in volatility, and this is raising the awareness and importance of managing commodity risk among corporate treasurers and asset managers.”

Techniques that companies can use to protect themselves against the risks of commodity prices include hedging through derivatives, or passing increased costs on to customers.

Broader inflationary pressures are also occupying risk managers’ minds.
Mario Vitale, deputy chief executive of global corporate at Zurich Financial Services, says inflation affects the amount of insurance cover on property and equipment, for example.

“Today’s risk-management programmes will be different even from a year ago. There will need to be a much closer analysis of what is the proper replacement value to insure for,” he says.
As companies expand outside their home markets and into new territories, life becomes even trickier.

Corporations are increasingly outsourcing non-core operations to third parties, often in offshore locations, or are shifting manufacturing to locations with a lower cost base. Cheaper locations may face an increased risk of natural catastrophe or political instability. Companies must also take the resilience of suppliers into account when they make decisions about sourcing.
“The further you go down the food chain, the more likely you are to have organisations that fall over,” says Mr Bryn.

Indeed, Charles Beach, a director in PwC’s risk and capital team, cautions that a focus on the financial crisis could blind companies to risks in other areas.

“One of the things we have been warning against is the tendency to always fight the last war,” he says. “Whilst people are looking at the subprime crisis, which emanated originally out of the US and has been a first world crisis, there has been continuing huge growth in emerging markets, in places such as Asia. One of the things we have been warning against is taking your eye off the ball there.”

But Julia Graham, chairman of the Association of Insurance and Risk Managers (Airmic), says: “It is a very good risk control being a global business. If you can spread your risk globally, that is actually, obliquely, a very nice risk-management control.”
She says some organisations are shifting emphasis, for example focusing on the Middle East, or parts of Asia, rather than the US.

Companies are under increasing pressure to manage their risk effectively. For example, Standard & Poor’s, the credit ratings agency, is now taking risk management into account when it decides on a company’s rating. But inevitably, in a harsher economic environment, there will be pressure to cut costs.

Richard Sharman, a partner in KPMG’s risk advisory services group, says: “Now really is the time to be looking at that investment and making sure it is adequate. It may be you need to spend less, but for many companies it means you need to spend more on risk management.”
Risk management not only protects against unwanted events – it also helps identify opportunities and deliver value for shareholders. In tougher times, both are more crucial than ever.
“If you do [risk management] better you are more likely to survive than the business next door to you,” says Airmic’s Ms Graham.
“Risk management is about looking over the hill. But a lot of boards look at the hill, not what is over it. One of our jobs is to make sure they keep looking beyond, and not just at what is in front of them.”

The Crisis In Logos

http://www.investmentpostcards.com/2008/11/26/the-crisis-in-logos/

Lessons from Obama's Win from the Welchway

An article that I find has lessons to be learnt in our risk management efforts.

Link

http://www.welchway.com/Management/US-Economy-and-Government-Policy/Matters-of-State/Barack-Obama-s-Victory--Three-Lessons-for-Business.aspx

This column is not about ideology. The election is over. And while we believe John McCain is a great American whose economic platform made better sense for business, especially in terms of free trade, tax policy, and job creation, we look forward with hope to the Presidency of Barack Obama. If his is an America for all people, as he has so passionately promised, then surely it will also serve the interests of the millions of hard-working small-business owners and entrepreneurs who are so much a part of this country's strength and future.But enough of politics.This column is about the lessons business leaders can take from McCain's loss and Obama's win. Because even with the differences between running a campaign and a company, three critical leadership principles overlap.

And it was upon those principles that Obama's decisive victory was built.

Start with the granddad of leadership principles: a clear, consistent ­vision. If you want to galvanize followers, you simply cannot recast your message. Nor can you confuse or scare people. McCain's health-care policy, for example, had real merit. But his presentation of it was always confoundingly complex.Meanwhile, Obama's message was simple and aspirational. He talked about the failings of George W. Bush. He talked about change and hope and health care for all. Over and over, he painted a picture of the future that excited people. He also set a perfect example for business leaders: Stick to a limited number of points, repeat them relentlessly, and turn people on.

The next leadership principle should sound familiar: execution. In their seminal book by the same name, Larry Bossidy and Ram Charan made the case that execution isn't the only thing a leader needs to get right, but without it little else matters. This election proves their point. In nearly two years of steady blocking and tackling, Obama's team made few mistakes. From the outset, his advisers were best in class, and his players were always prepared, agile, and where they needed to be. McCain's team, hobbled by a less cohesive set of advisers and less money, couldn't compete.

Another, perhaps bigger, execution lesson can be taken from Obama's outmaneuvering of Hillary Clinton for the Democratic nomination. She thought she could win the old-fashioned way, by taking the big states of New York, Ohio, California, and so on. He figured out an unexpected way to gain an edge—in the usually overlooked caucuses.The business analog couldn't be more apt. So often, companies think they've nailed execution by doing the same old "milk run" better and better. But winning execution means doing the milk run perfectly—and finding new customers and opening new markets along the way. You can't just beat your rivals by the old rules; to grow, you have to invent a new game and beat them at that, too.

Finally, this election reinforces the value of friends in high places. From the start, Obama had ­support from the media, which chose to downplay controversies involving him. Meanwhile, after the primaries, McCain began to take a beating. In the end, no one could dispute that Obama's relationship with the media made a difference. As a business leader, you can't succeed without the endorsement of your board. Every time you try to usher in change, some people will resist. They may fight you openly in meetings, through the media, or with the subterfuge of palace intrigue. And you'll need to make your case in all those venues. But in the end, if your board has your back, defeat can be turned into victory.That's why you need to start any leadership initiative with your "high-level friends" firmly by your side, convinced of the merits of your character and policies. But that's not enough. If you want to keep your board as an ally, don't surprise them. Think about McCain's "gotcha" selection of Sarah Palin. Scrambling to catch up with the story, the media was not amused.Surely pundits will scrutinize this election for years to come. But business leaders can take its lessons right now. You may have winning ideas. But you need much more to win the game.

Snapshots of market doom and gloom

New lows in Dow

7,552.29 close

Oil dives below USD50.

• CMBS trading with yields around 13 percent, knocking them down to the same category as junk bonds, despite their top rating


• JPMorgan poised to cut investment banking staff


• HSBC trimming 500 staff in Asia


• Citigroup to shed 50,000 staff

INDONESIA

• Indonesian Rupiah down 23% this year against USD


• Indonesia changed its currency rules to make it more difficult to buy foreign exchange, requiring any purchases involving US$100,000 per month or more to support by transaction in goods or services. The measures, mostly affecting Indonesians rather than foreigners, would make speculative bets against rupiah depreciation more difficult.


• Oil and gas regulator, BPMigas, said it would order oil-and-gas contractors to use local banks to deposit the billions of dollars earmarked for energy.

Important vs. Urgent and the importance of delivering the risk message

This was perhaps the best perspective from the conference today that I hope to use in framing our efforts in risk management in this organization

Thoughts on leadership

• People want to grow and be challenged
• People need new challenges regularly
• People want to be given opportunities to take on new responsibilities
• People needs to feel that they belong
• It takes time for people to show their potential
• People want to contribute to the organization

Thoughts on supply chain risk management

Holistic approach in supply chain risk management is not about supplier risk rather the inter-related elements of :

• Supplier risk
• Supply region risk
• Supply chain risk
• Commodity risk

More thoughts coming on this!

Responding to the financial crisis

Risk management is a combination of both art and science with the view to predict and manage the uncertain future. The financial crisis has provided us in the risk management fraternity to demonstrate the value proposition in managing risks.

Unfortunately in the midst of risk framework and processes, documentation, workshops to discuss risks and not to mention countless meetings, risk management in my view has become an academic exercise of identifying risk drivers or factors, assessing impact of these factors onto the exposures we have, and developing mitigation plans and strategies.

This creates the perception that is what risk management is all about when there is another important element : execution of the identified mitigation plans and strategies, putting to test the practicality of the strategies that shows much promise and provides assurance to management in beautiful PowerPoint slides and therefore, manage risks.

Therein lies the fundamental problem : That those in enterprise wide risk needs to have the perspective of reality facing businesses in managing the business portfolio and the risks and that it is not just about managing downside risks but also upside risks, and making the risk-return trade off decisions just as one would in the portfolio optimization, generating maximum returns for a stated level of risk, or minimizing risks for a stated level of return.

In the situation that we face arising from the financial crisis, we were caught unprepared because perhaps we have been dealing with known risks but not the unknown and unknowable. When the crisis hits, while the speed of which we responded during and post crisis, but were we prepared for the potential financial repercussions?

For example, we have always operated under a situation where access to banks and credit has been so many years that when credit conditions tightened considerably, it became difficult for companies, be it our customers or suppliers, to function as a business. Was banking system risk in our list of potential risks?

Right now what was risk management has turned into crisis management in our efforts to assess our ability to ride this financial turmoil. The crisis should be viewed as an opportunity to assess again the risk management value proposition, and lessons learnt can definitely be turned into shaping the practice of risk management in this organization centering on key elements of risk governance, risk integration, risk infrastructure and last but not least, the act of managing risks.

For those who are interested, I am in the midst of preparing lessons learnt from the financial crisis and long-term ramifications in shaping the practice of risk management.

Please note that this is my personal observation and does not in anyway denote that current risk management efforts are futile, but opportunities exist in re-shaping the risk management practice and transforming risk management as a competitive edge.

The philosophy of integrated risk management

Guest column: Internationalisation – risk or opportunity?
By Torsten Jeworrek


The internationalisation of the economy is not as recent as the buzzword “globalisation” would have us believe. In fact, it was internationalisation that paved the way for the beginnings of the insurance industry back in the 14th century, as shipowners sought to protect the increasing value of their ships and cargoes. A document from 1347 is believed to be the oldest marine insurance contract.

Even today, the complex nature of risks emanating from international trade is one of the insurance industry’s most difficult challenges and one that affects all classes of business, as the following examples show:

1. More than 90 per cent of all world trade is transported by sea or other waterways. The largest container ships today, with cargoes of up to 13,000 containers, may be worth far in excess of $1bn. However, even this concentration of values is small compared with that found at the world’s great container ports, such as Singapore or Hamburg, which act as depots to goods worth tens of billions of dollars every day.

2. The outsourcing of production sites to low-wage countries does not just reduce costs. It can also reduce the quality of the goods produced. Defective products can result in recall costs or even product liability costs. Recent examples of recalls that spring to mind include toys coated with lead paint and toothpaste contaminated with the antifreeze diethylene glycol.

3. Liability losses can reach extreme proportions when pharmaceutical products cause dangerous side-effects in patients. National law in the country where the products are sold plays a key role in this connection. The US, in particular, has seen some extremely high awards for damages. For example, in November 2007 pharmaceutical giant Merck had to pay $4.85bn damages in the US alone following several thousand cases of heart attacks and strokes caused by its Vioxx painkiller.
These examples highlight the enormous extent of the insurance industry’s role in the global economy.

Insurance companies that cover such large risks need a secondary market where they can place them. Reinsurers assume this function. Sharing the load among several carriers helps to spread the risks. The diversification effects achieved by spreading risks across different regions and classes of business allows reinsurers to balance their portfolios and realise a level of capital efficiency that enables them to cover their clients’ risks – and ultimately those of the insureds – at a reasonable price.

Extreme losses in the past show just how important the reinsurer’s role is. One of the biggest loss events in the history of insurance was on September 11, 2001. The attack on the World Trade Center in New York was a prime example of the complexity of today’s risks, with accumulation of losses across a range of insurance classes such as fire, business interruption, liability, life and health, and compounded by significant capital market losses. The economic losses could only be remotely estimated at $100bn. The losses for the international insurance industry came to $40bn, with $24bn of this covered by the reinsurance industry.*
The insurance industry also bore the brunt of the losses in the 2005 hurricane season with Rita, Wilma and Katrina. Some US$ 94bn of the aggregate losses of US$ 180bn was borne by the insurance industry, US$ 42bn by the reinsurance industry alone. *

The insurance of large and accumulation risks is a definite advantage for the sustainable development of economies. In countries where insurance is not very far advanced, it is the vulnerable economies and above all the inhabitants that have to bear the brunt of these losses. The tsunami of 2004 not only brought immense human suffering but also caused losses of over US$ 10bn. As the insurance density in the regions affected is still very low, the insurance industry only covered a small percentage of these losses, less than US$ 1bn.*
Countries with an underdeveloped system of insurance suffer immeasurably more from major catastrophes than those where a good part of the material losses can be covered by professional risk carriers.

Reinsurance has always been an international business since its beginnings in the middle of the 19th century. By assuming a number of independent risks in different regions of the world, reinsurers create a balance in their portfolios. However, the causal and regional links between risks used to be much less pronounced than they are today. The global economy is increasingly networked and interconnected. Risks are becoming ever more complex and the insurance industry has to develop new concepts for its clients in order to meet their need for risk cover in this changed environment.

To respond to this development, enterprise risk management has become increasingly important, especially for reinsurers themselves. They have to consider not only the complexity of the original risk, but also the fact that one and the same risk frequently comes from a large number of different sources, such as through international insurers.

To deal with these challenges, Munich Re has founded a central unit, Integrated Risk Management, which is responsible for uniform group-wide identification and handling of large and accumulation risks.

The regional business units, supported by a global network of local units, are thoroughly familiar with the special features of the individual markets. Together with clients, they develop solutions for the assumption of risks. Centralised risk management processes ensure that cross-regional and cross-line risks are identified and suitably limited in Munich Re’s aggregate portfolio.

In this process, there is clearly a lot more to consider than just the underwriting risk. For example, if we cover significant product-liability risks of a pharmaceutical company, we do not then buy large amounts of stock in this company. This ensures that we are not struck twice when large claims payments are accompanied by a fall in the company’s share price.
Failure to implement such a holistic risk management policy can lead to a dramatic underestimation of the true risk position.

This has been evident in the current financial market crisis. For successful risk management, it is essential to identify concentration risks and systemic risks for which diversification in the portfolio does not work.

Far-reaching risk trading mechanisms can lead to very high systemic risks for the entire sector involved. The insurance industry has therefore created global standards. It learnt its lessons from the LMX (London Market Excess of Loss) spiral in the late 1980s, where risks were passed on endlessly in the London market. Two key principles in the global insurance systems are that players must have a sizeable retention in the insurance risk, and that risk transfer in the insurance sector ends with retrocession, or the protection of reinsurers. There may be no further transfer of risk beyond this.

Munich Re seeks to achieve a suitable balance between opportunity and risk – to play a meaningful role in global economic development and in so doing create profit for our stakeholders.

At the same time, we also want to contribute to economic and technological progress and thus to the development of society as a whole. We do this by providing our clients with as much capacity as possible and with optimal innovative solutions – for example through the cover of new climate-protection technologies.

With our Integrated Risk Management we ensure that our company is protected against losses that may threaten its existence – so that we are always in a position to meet our obligations to our clients.
*All the loss estimates above are in 2007 dollars (adjusted for inflation).
Torsten Jeworrek is a member of the board of management at reinsurer Munich Re.

Link

http://www.ft.com/cms/s/0/74d43adc-b43e-11dd-8e35-0000779fd18c.html
Copyright The Financial Times Limited 2008

Making headways

The meeting today was indeed fruitful in that we understand the country platforms where risk and more importantly the management of risk can be integrated. We discussed the escalation approaches,the rationale for such approaches, the efforts currently underway led by IBU and the need to expedite management of risks given the situation facing us now.

Looking forward to forging new relationships!

Things occupying my mind

Sometimes I have too many things occupying my mind that it becomes paralysis by analysis or perhaps over-analysis. I would like to think that at this juncture in my career I should work differently and that the leadership I provide is the one that ultimately matters and not the nitty-gritty of the various aspects of financial risk management. So why do I feel that I have not delivered?

Things occupying my mind and in no particular order of importance:

1. The CFP Compliance and its analysis for two very big entities within the Group.
2. The CFP Supporting Guidelines that is long overdue
3. The long-term perspectives of CFP in terms of consistency in approach, governance, building capability as advisor
4. Alignment to Group Risk efforts and the effort it takes knowing how I approach things
5. The issuance of alerts that needs to be sent out
6. The management (or mismanagement) of a major systems upgrade project
7. The foundations of a major project, resource management with the stretched resources that we have, the overall approach
8. The different philosophy that I have in leading the financial crisis task force
9. Staff development, coaching and feedback
10. Managing market risks vs. counter-party risks
11. Leading the FX in Financing Value Chain initiative
12. The PCP Engagement Session and coordination of such a meeting
13. Indonesia Country Risk Strategy and our role in providing the financial risk perspective

The list goes on and on....when can I take a breather?

HELP!

A new framework for supply chain risk management

It is precisely due to the issues faced below in supply chain risk management that we require a new approach in supply chain risk management. Read on and tell me what you think. Are we facing the same issues? How are we managing these risks?

The idea of a "crisis cell" might suggest counterterrorism more than it does corporate risk management. But at Safran, the French aerospace and defence company, it is the name of a team charged with responding to the ever-increasing pressure on its global supply chain.
Safran's crisis cell monitors the group's 4,000 suppliers, which receive €5.3bn ($6.7bn, £4.5bn) in total a year in return for products and equipment. Xavier Dessemond, Safran's purchasing director, says the aim is to deal with the problem in "a preventative manner". He adds that while no supplier has yet experienced great difficulties, "We know there is a crisis and we know our industry will be probably affected".

It is a growing concern for manufacturers worldwide. Companies' supply chains have become far more global in the past decade, with the consequence that stress from the financial crisis is spreading quickly to suppliers large and small. It is testing the global supply chain to an extent rarely seen and spurring companies in industries from aerospace to retailing to take extraordinary measures.

VT Group, a leading British defence group, is a good example. The former Vosper Thornycroft has a solid business, as many of its orders come from the UK government. But in the past two weeks it summoned its leading 100 suppliers - which account for about 70 per cent of its £500m ($740m, €580m) annual supply budget - to a meeting.

The message from Paul Lester, chief executive, was stark: "If you get into financial difficulties, don't delay but come and talk to us. You are probably better talking to us than banks, because banks aren't really doing their jobs right now and we can help."

Possibilities for help include paying suppliers in cash earlier, giving them longer orders or even lending them workers, says Mr Lester. At Safran, Mr Dessemond says his company could put capital into its suppliers, help them obtain aid from government agencies or change payment terms - but all only in "exceptional cases".

Mr Lester says simply: "We want a bloody good supply base. And we are just nervous that, particularly among SMEs [small and mid-sized enterprises], somebody will get into difficulties."
A small software supplier to VT did go bust recently - the latest in a number of European supplier collapses, from Stankiewicz, the German car parts supplier, to several manufacturers that serve UK retailers.

All this marks a huge shift for many large industrial groups. During the summer, much of the talk focused on whether their suppliers had the capacity to keep up with demand. "It is amazing how the conversation has changed in the last few months," says Aaron Davis, the marketing director of Schneider Electric, the French energy management company.

Now, many suppliers are more likely to be calling to ask for bail-outs. The culprit is obvious, according to manufacturers: it is the banks. VDA, the German carmakers' association, accuses some banks of "making credit lines more expensive, withdrawing them or making credit due in the short term". Ratings agencies such as Moody's and Fitch point to the increased difficulties small and medium-sized companies face in securing credit from banks.

But the big companies may also be partly to blame. Many have squeezed suppliers mercilessly for years. The car industry is renowned for manufacturers suddenly imposing demands for 10 per cent across-the-board cuts in component prices. Likewise, UK retailers led by Tesco have succeeded in pushing payment terms with suppliers increasingly in their favour. Tesco has increased the time it takes to pay for some goods from 30 to 60 days.

Bart Becht, chief executive of Reckitt Benckiser, the consumer goods group, last month criticised such moves as making no sense. According to an industry insider, meanwhile, suppliers have complained in recent days that another large supermarket group has just asked for 15 per cent price cuts.

Julie Metelko, a business improvement specialist at PA Consulting, says that approach risks backfiring on large companies: "If suppliers aren't getting cash, then you risk taking them out."

That is why companies such as Daimler, the German luxury carmaker, and some of its rivals are looking at giving cash straight to suppliers in difficulties. "Three hundred thousand jobs are at risk in this industry - due to a crisis that was not caused by small and mid-sized companies but [which] is making them suffer massively," says Dieter Zetsche, Daimler's chief executive. Volkswagen, Europe's largest carmaker, has set up a special team to stop suppliers from collapsing.
Counterparty risk is well-known in the financial world, where it refers to the chance one side of an agreement will default. As it becomes a concept to be reckoned with in the real economy, manufacturers are checking their exposure. "We have got to look at risk in the supply chain much more closely. Is your Chinese supplier financially sound? Are they capable of maintaining your supply?" asks Tim Lawrence, a supply chain expert at PA Consulting.

Many counter that they have double or triple sourcing, with suppliers for the same part spread across the world. "In tough times like these, you need as much as possible to keep two suppliers. Globalisation helps here," says Pierre-Jean Sivignon, chief financial officer at Philips, the Dutch electronics group. Don Gogel, chief executive of Clayton, Dubilier & Rice, the US private equity firm, says: "Globalisation is a big positive, as it has led to multiple suppliers around the world."
But doubts remain. One is over how quickly a supplier can respond to take over the capacity if one of its rivals collapses. Another is the fact that some components are so complex they are manufactured only by one supplier. Additionally, companies such as carmakers often use one supplier for each model or project, meaning changing component makers could take months.
Just-in-time delivery - long the mantra of many manufacturers worldwide - is also turning into a possible weakness in the supply chain. A problem with just one supplier can throw the entire system into chaos, as can shipping difficulties. Manufacturing experts say that for those and other reasons they are starting to see western companies bring back operations or suppliers from far-off countries in Asia to closer to home: eastern Europe or Mexico.

"We are hearing about it more and more - that companies that went to China and elsewhere in Asia for the low costs are facing rising energy and labour costs. So they are bringing production back closer to home either to the UK or more likely to eastern Europe," says Jane Lodge, head of the manufacturing industry team at Deloitte in London.
Reports suggest 67,000 factories in China closed in the first half of this year because of the slowdown in exports. Richard Meddings, chief financial officer at Standard Chartered, says the Asian-focused bank is looking much more closely at what is happening to small and mid-sized companies as well as exporters. But he says Asia is still holding up well: "It is coping quite well but the world is obviously slowing. The order chains are still working."
Once-booming countries such as Russia are suffering more. Yann Vincent, chief operating officer of Avtovaz, the country's largest carmaker, says: "We have suppliers that are crying. They say, 'If you don't pay us x million roubles, we won't be producing - because we don't have credit'."
Other big risks remain in the supply chain. One is the reduction of inventory levels - known as destocking - that is taking place across many industries. "There is a huge effect of massive destocking in all supply pipelines. Lots of people are waiting to buy things as they believe raw materials will only become cheaper. It is a vicious spiral," says Feike Sijbesma, chief executive of DSM, the Dutch life sciences company. Destocking has also occurred in retail supply chains in a big way despite Christmas being so close.

One factor driving the cuts in stock is the approach of the end of the year for accounting. Many companies are keen to have as much cash on their balance sheets as possible by year-end. Ms Metelko says: "Everybody is being much more aggressive this year, especially as they're looking at weaker demand."

Daniel Corsten, a professor at the IE Business School at Madrid, says these are desperate times for some otherwise solid suppliers: "Supply chains are generally in good shape . . . But what we see now is very worrying. Previously robust suppliers in terms of quality and reliability cannot finance their production cycle any more. Shrinking demand means that customers pay late, less, or default, and as a consequence suppliers receive theirs less and late. Counterparty risk has reached the real economy."

The troubles faced by Land Rover's Discovery four-wheel-drive vehicle shows how much havoc can be wreaked by a problem in the supply chain. In 2002 Land Rover, then owned by Ford, said it might have to stop production of the Discovery because the only supplier of its chassis - UPF-Thompson - had gone bankrupt.
The carmaker estimated it would have taken six to nine months to find an alternative supplier, putting 11,000 jobs at risk at Land Rover and its suppliers. The cost of having dual suppliers would have doubled the £12m ($18m, €14m) investment needed for the chassis, the company said at the time.

The end result was messy. KPMG, the receivers for UPF, demanded about £60m from Land Rover to maintain supplies of the chassis. Land Rover accused KPMG of holding it to ransom and the matter ended up in court. Under a settlement, Land Rover paid an estimated £15m to take on UPF's debt.

Land Rover said the case underlined the need to reform bankruptcy law. But, in an illustration of the complexity of such issues, UK ministers were unsympathetic as they believed the carmaker had negotiated an original price on the chassis that left UPF making a loss on every component.

Copyright The Financial Times Limited 2008

This new responsibility and what to make of it

Act locally to embed the right attitude to risk

Published: November 17 2008 02:00 Last updated: November 17 2008 02:00
From Ms Gail Easterbrook.

Sir, World leaders at the weekend's Group of 20 summit in Washington may have discussed the idea of giving the International Monetary Fund new regulatory powers - to provide an "early warning" of risks to the global economy. And good luck to them. Meanwhile, directors and managers must act locally if they are to avoid repeating the mistakes that led to the global financial crisis. Risks that matter to companies cannot be macro-managed by an international watchdog. Every organisation should examine and construct its own "risk culture".

Self-regulation is the best way for the board of any business to address the risks it is likely to encounter and implant the right controls. This is how to create an ethical and effective corporate environment.

Risk is not something to be avoided. It should be embraced. Without risk there are no rewards. It is a matter of embedding the right attitude to it. To achieve a healthy risk culture, Boards must invest adequately in risk management resources. A highly trained internal audit function will help senior management develop a strategic overview of all the risks an organisation faces. A system of controls, correctly monitored, can provide assurance to the board.

Every day there is a new call for directors and non-executives to look properly and clearly at the risks to their organisations. One glance at the results of the mismanagement of risk in the banking sector should be enough to send many directors with renewed purpose back to the boardroom. There, a free and frank discussion should ensue. It's around the boardroom table, not at the G20 summit, that risk management begins.

Gail Easterbrook,
Chief Executive,
Institute of Internal Auditors - UK and Ireland,
London SW4, UK

Free and frank discussion in the boardroom....this will indeed be a new challenging journey for me!

Rising costs erode oil industry's profits

From the Financial Times

By Ed Crooks in London

Published: September 3 2008 23:36 Last updated: September 3 2008 23:36

Oil companies’ profitability fell last year as rising costs eroded gains from the rise in oil prices, an industry study has found.

The companies’ return on capital from their oil and gas production fell to 19 per cent, 3.5 percentage points lower than in 2006, according to the study from IHS Herold, a research firm, and Harrison Lovegrove, a corporate finance firm owned by Standard Chartered bank.

The study of 232 leading quoted oil and gas companies also found that they had not increased their total reserves last year, and raised production only slightly.

Rodney Schmidt of Standard Chartered suggested that if oil prices continued to fall, oil companies could face growing difficulties. “We are now at a point of greater uncertainty...where there are questions about demand and about where prices will end up. At the same time, profit margins have not been increasing.”

Company profits have been squeezed because costs have risen along with revenues, and governments of resource-holding countries have been taking a greater slice of the proceeds through tax increases or contract renegotiations.

Although big companies have still been making record profits, they have also had very high levels of capital expenditure. Organic capital spending, excluding acquisitions, has soared from $139bn in 2003 to $342bn last year, the study found.

The result has been that, in spite of the steep rise in oil prices over the decade, profitability has risen only slightly from 16.5 per cent of cumulative capital costs in 2003 to 19.1 per cent last year.

The difficulties facing the industry are also reflected in slow production growth, which averaged just 1.3 per cent last year. Production increases in the US, Russia and the Caspian area and the Asia Pacific region were offset by declines in Canada, Europe, and South and Central America.
Companies also found it hard to add to their reserves: proved oil reserves dropped by 1.5 per cent, while gas reserves rose 3.3 per cent, reflecting a shift by many international companies away from oil towards gas, which is often more difficult to extract and market profitably.

Copyright The Financial Times Limited 2008

Things occupying my mind

What makes risk management interesting

The challenges in financial risk management is keeping up with changes within the organization and assessing that impact to risk management; in other words moving on with times. The demands by multiple stakeholders in terms requires you to shift thinking caps and the learning curve for me and for my team is very steep in order for us to stay at par with organizational change, if not ahead, and simulatenously meet the demands of the stakeholders i.e. senior management, OPUs and HCUs.

Things occupying my mind categorized but not necessarily in the order of importance.

Integrated Financial Risk Management

• Pilot company compliance checklist report
• Supporting guidelines that needs to be re-written, both in terms of documentation and content
• The review with CFO of the pilot company
• The remaining 1st phase OPUs for CFP roll-out
• The risk council meeting this 23rd September
• Sharing session with Group Risk Management on CFP implementation
• Revised timeline for all of the above

Measurement and Reporting

• Getting to a total view of FX Risk exposure
• Revised Dashboard to incorporate having a total view of FX
• Framing the context of foreign exchange exposure for the group of companies
• Risk systems transition and implementation
• Progress in implementing stress testing framework for financial risk exposures
• A framework for FX Risk Management for the upstream OPU

To be continued.......

Asset Liability Management

Compliance and Control

Initiatives deadline

Perspectives in Currency Risk of a Non Financial Corporation - Part 1

How do you frame the context of foreign exchange risk in a non-financial corporation?

Setting objectives

The objectives of risk management must be clearly articulated in terms of risk and return. The objectives set must be able to answer the concern of volatility of risk factors and how the corporation is impacted by this volatility. The metric upon which this volatility impacts the organization must also be defined. For example :

• Is the corporation concerned with the volatility of its cash flows impacted by risk factors such as foreign exchange and commodity prices?
• How does cash flow volatility impact the corporation's strategic business objectives? Will cash flow volatility exposure to risk factors left unmanaged will cause the corporation to reject potential business investment opportunities?
• What are the corporation's growth strategies and will cash flow volatility result in expensive ignorance of profitable opportunities?
• Linking this to performance reviews, how does cash flow volatility impact the firm's return on invested capital and more importantly, how does a firm gets the assurance that these risks are managed?

Knowing what is at risk : Economic exposure vs. accounting exposure

In setting objectives, we should also be clear on whether we are concerned about managing volatility of economic exposures or volatility in accounting exposures. This clearly will have some bearing especially if reported numbers through the strategic planning group relies heavily on accounting numbers. These two concepts will result into risk exposures that are very different. Economic exposure in general refers to the economic realities of the extent a corporation is affected by exchange rate changes. Accounting based foreign exchange gains and losses typically gets reported and many senior management are typically preoccupied with these numbers.

In making the distinction between economic vs. accounting exposure, one can use a few examples to illustrate. From an exposure recognition perpective, a revenue flow is recognized in accounting terms when an invoice is issued and the sales is recorded with a corresponding record of the account receivable consistent with the accrual accounting method. The economic exposure however would already be recognized at the bill of lading date, where a provisional invoice is issued, and the amount and timing of cash flows is still uncertain.

Similarly for expenses. Say if a project has been sanctioned and a contracting strategy has been developed. The economic exposure would recognize the impact of exchange rate changes in the project economics stage and once sanctioned, the impact of exchange rate changes in the expected future cash flows of the project. The accounting exposure would follow liability recognition rules, where liability is recognized when services have been rendered or goods have been received.

In a nutshell, the time pattern of an economic exposure happens much earlier than that of the accounting exposure, and that should be basis for exposure recognition in risk management.

Knowing what is at risk : Defining the metric

Accounting exposure focuses on the impact of exchange rates on reported earnings and in shareholders' equity, dependent on accounting rules that dictate how a transaction is recognized in the accounting books or how subsidiary balance sheet translation impacts that of the parent company.

Economic exposure focuses on the underlying cash flows of the firm; in this context the impact of exchange rate changes in the expected future cash flows of the firm.

In this regard, the expected future cash flows of the firm sensitivity to exchange rate changes or risk factors can be viewed in terms of its impact to the firm value (i.e. present value of future cash flows) or in terms of real operating exposure. Real operating exposure refers to the impact of exchange rate fluctuations on future revenues and costs i.e. its operating cash flows.

The link between operating cash flows and firm value

Getting a total view of the impact of exchange rate fluctuations onto operating cash flows

To assess the impact of exchange rate fluctuations onto operating cash flows requires a detailed understanding of the firm's core business operations and its cash flows and in a large organization such as ours requires also understanding the inter-company linkages. Once these cash flows have been identified, the risk exposure, whether in terms of sensitivity of cash flows to exchange rate changes or a more sophisticated measurement method of assessing the volatility of exchange rate risk factors onto the cash flows, therefore cash flow at risk, can then be performed.

To be continued