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PwC
PwC survey
October 2011
3
“Risk management is seen as a necessary evil in our organisation, and the group risk manager is still trying to sell the benefits”
CFO
PwC
Continuum of risk
October 2011
4
Known risks Emerging risks Unknowable risks
Happened before
Cause
Impact
Probability
Several competing plausible models as to how reality might unfold
Unforeseeable
Have not yet emerged
e.g. earthquake, major debtor default, supplier failure
e.g. major terrorist act, climate change
Black swans
e.g. volcanic ash cloud?
PwC
What do we mean by „High Impact‟ Risk?
October 2011
5
Likelihood
Imp
ac
t
1
2
4
3
11 12
9
10
7
5
8
6
Any inherent risk scenario
where the impact could be catastrophic:
• may arise from any category of risk (strategic, operational, financial etc)
• may be known, unknown or emerging
PwC
The challenge of dealing with high impact risk
• Traditional risk management approaches tend to downplay the importance of risks with low probabilities of occurrence attached to them
• Events with a low probability of occurrence are difficult to assign meaningful measurement to – impact and probability
• Challenge to get people engaged in fully considering remote probability risks – some may not even be foreseeable at all
• Often unclear whether controls over high impact / low probability risks are really working
• Lack of experience in dealing with such risks within the company – because they happen relatively infrequently
• High impact risks may correlate with others, causing them to occur or magnifying the combined impact
October 2011
6
PwC
Value destruction in companies
October 2011
7
39% 28%
19% 14%
Demand shortfall
Customer retention
Integration problems
Pricing pressure
Regulation
R&D
Industry or sector downturn
JV or partner losses
Macroeconomic
Political issues
Legal issues
Terrorism
Natural disasters
Cost overrun
Operating controls
Poor capacity management
Supply chain issues
Employee issues incl. fraud
Regulation
Commodity prices
Debt and interest rates
Poor financial management
Foreign exchange
Liquidity risk
Accounting problems
Strategic Operational
Hazard Financial
Bribery and corruption
PwC
Financial risk management objectives
October 2011
8
Protect the organisation against unforeseen losses, maintain earnings stability, maintain certainty of cash flow, protect ability to meet budget
Benefit where possible from favourable movements in market rates without exceeding the risk attitude of the corporation
Deliver shareholder value
PwC
Areas of financial risk
October 2011
9
Risk created by market conditions and movements
Debt and interest rate
• Exposure to interest rate movements
• Repayment schedule
• Ability to extend credit
• Covenants
Foreign exchange
• Transactional risk in contracts in foreign currencies
• Exposure where cash held in foreign currency
• Exposure to movements in MNT
Market (commodity) price risk
• Impact of movements in commodity prices
• Competitor price risk
• Inflation
PwC
Areas of financial risk
October 2011
10
Risk related to structure and business
Credit risk
• Counterparties unable to meet obligations
Liquidity risk
• Insufficient cash to meet existing or future requirements
• Ineffective use of cash and working capital
PwC
Areas of financial risk
October 2011
11
Regulatory and compliance risk
Tax risk
• Changes in tax regulation
• Interpretation of tax regulation
• Failure to comply with requirements
• Failure to take advantage of tax opportunities
Legal risk
• Changes in legal framework
Other regulatory or compliance risk
• Changes in regulatory framework
• Failure to comply with regulation
PwC
Areas of financial risk
October 2011
12
People and performance risk
Poor financial management
• Lack of experience to take advantage of financial opportunity
• Failure to identify opportunities
• Lack of understanding of finance and implications
• Actions not taken quickly enough in response to changing circumstances
• Inaccurate budgeting, forecasting and monitoring
• Suboptimal investment decisions
Accounting errors
• Mistakes resulting in compliance risk
Fraud risk
• Misappropriation
• Misrepresentation
PwC
Approaching financial risk management
October 2011
13
1. Managing risks in isolation
Separate identification of exposures.
Hedging takes place by sub-risk type and by specific transaction.
Easy to implement.
2. Using a portfolio approach
Aggregate exposure identification
Hedge take place on both portfolio and transaction level
Provides better control on residual risk and can reduce cost of hedging
Requires effective and adequate systems infrastructure.
PwC
Financial risk management approach
October 2011
14
Debt
Trade FlowsCommitted
Flows
Uncommitted
Flows
Committed
Uncommitted
Non-Trade Flows
Committed
Uncommitted
FX
Interest
Equity
Commodity
• Sensitivity
• VaR
• What-If
• Worst case
• Profit &loss
• etc
Risk appetite
Return objectives
Meet?
LIMITS
Sets
Yes
No
Mitigating Action
Yes
No
Review optimal strategy
Recognise
sourcesConsolidate Manage
Measure
and control
Link to
strategy
BENCHMARKS
Sets
FX
Interest
Equity
Commodity
He
dg
e s
trate
gy
(Po
rtfolio
Ap
pro
ach
)
PwC
What is the best strategy?
Debt
Trade FlowsCommitted
Flows
Uncommitted
Flows
Committed
Uncommitted
Non-Trade Flows
Committed
Uncommitted
FX
Interest
Equity
Commodity
• Sensitivity
• VaR
• What-If
• Worst case
• Profit &loss
• etc
Risk appetite
Return objectives
Meet?
LIMITS
Sets
Yes
No
Mitigating Action
Yes
No
Review optimal strategy
Recognise
sourcesConsolidate Manage
Measure
and control
Link to
strategy
BENCHMARKS
Sets
FX
Interest
Equity
CommodityH
ed
ge
stra
teg
y
(Po
rtfolio
Ap
pro
ach
)
EXPOSURE ANALYSIS
• Quality of forecast• Forecast horizon• Business cycle• External business factors
DEFINE/QUANTIFY
• Risk appetite• Return• Objectives
ESTABLISH RISKQUANTIFICATION TOOLS
PwC
Maturity in managing financial risk
October 2011
16
Sophistication
Maximise shareholder value
Ensure earnings stability
Control losses
Riskidentification
Riskmeasurement
ControlRisk
control
Risk/return analysis
Capital allocation
based on RAPM
Strategicadvantage
Pricing and remuneration
based on RAPM
Tier 1 bank
Objectives
Typical large
multinational
Typical large
corporate
Tier 1 bank
PwC
Strengthen checks and balances
Be prepared: anticipate and scenario plan
Show leadership and shape culture
Understand risk
What are the four key lessons?
October 2011
17
Thank you
This publication has been prepared for general guidance on matters of interest only, and does
not constitute professional advice. You should not act upon the information contained in this
publication without obtaining specific professional advice. No representation or warranty
(express or implied) is given as to the accuracy or completeness of the information contained
in this publication, and, to the extent permitted by law, PricewaterhouseCoopers LLC, its
members, employees and agents do not accept or assume any liability, responsibility or duty of
care for any consequences of you or anyone else acting, or refraining to act, in reliance on the
information contained in this publication or for any decision based on it.
© 2011 PricewaterhouseCoopers LLC. All rights reserved. In this document, “PwC” refers to
PricewaterhouseCoopers LLC ehich is a member firm of PricewaterhouseCoopers
International Limited, each member firm of which is a separate legal entity.