Insights into Mining - KPMG corporate filings of five major Canadian mining companies ... as companies seek to improve the risk profile of their portfolios ... Insights into Mining

Insights into MiningIssue #3

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Welcome to Insights into Mining, a periodic e-newsletter focused on current topics relevant to the Mining Industry.

KPMG’s mining practice is committed to the industry and will periodically publish a series of insightful articles authored by leading KPMG Mining professionals and advisors. The articles are designed to inform and stimulate debate amongst those involved in the industry. If you have any questions, please contact your local KPMG representative or click here for a list of KPMG’s Mining leaders across the country.

Anthony Bell Senior Manager,Risk Consulting

Exploring linkages between risk and strategyMining-specific insights into managing strategic risks

Like most businesses, mining companies establish strategic objectives to pursue successful outcomes for their stakeholders. The achievement of these objectives can be helped or hindered by many factors that are often unforeseen. Identifying and managing strategic risks – risks that have a direct impact on an organization achieving strategic objectives – has risen to the top of the agenda for most mining companies. With stakes so high in the mining industry right now, some strategic objectives have become too important to fail.

If identifying and managing strategic risks is a top priority, how well are mining companies performing that task? Over the past several years, many mining companies have adopted the process of integrated risk management, which involves identifying, analyzing and handling a complex web of risks. Integrated risk management is often performed from the “bottom up,” aggregating and ranking risks so those with the highest combination of potential damage and likelihood

© 2015 KPMG LLP, a Canadian limited liability partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.

2 Insights into Mining

rise to the top for reporting purposes. This bottom-up approach, although aligned with elements of accepted risk management standards (which recommend managing risks at all levels within an organization including from the top down), can pose particular challenges for mining companies when performed in the absence of “top down” risk management. It can turn risk management into a bureaucratic exercise that obscures the linkages between risk and strategy, and brings non-strategic operational risks to the attention of senior management and boards instead of key strategic risks.

Early strategic decisions to limit riskMining is a unique and inherently risky business. Reserves of metals and minerals must be discovered through a process of exploration and development that is financially risky, because it may

or may not deliver the rewards that were anticipated. Once extracted, mining products are commodities subject to boom and bust cycles. While most companies have the opportunity to price their products and services, most mining companies must settle for the current market price. Both of these dimensions of mining are unavoidable, both are fraught with risk, and both drive the decision-making and strategic direction of mining companies.

Mining executives have made a decision to work in this risk-prone industry, and they often approach its uncertainty with a prospector’s spirit. However, as mining companies grew into larger corporations, they began making strategic decisions to limit their risk. For example, some large companies gave up their in-house exploration groups, choosing instead to leave that risk with junior companies they could acquire later on. When faced with persistent commodity price risk in the ‘80s and ‘90s, others implemented a hedging strategy to reduce commodity risk.

As the mining industry has globalized over the past 25 years, companies have become even larger and more complex. As a result, today’s mining majors have added several more risks to the list they consider critical to manage. Many of these risks are financial, including liquidity risk, risk of capital and operating cost overruns, risks associated with capital



allocation, and more. Many others are geopolitical, including resource nationalism, political strife, permitting risk, and community relations.

A small informal research project conducted by KPMG looked at the corporate filings of five major Canadian mining companies to compare the risks they disclosed 10 years ago with the risks they disclose today. The average number of risks has increased by a third, from 26 to 35. Among the new risks disclosed are:

Although none of these risks was disclosed in 2005, they all existed; which goes to show that the greatest challenge in managing risk is often identifying and understanding what it is in the first place.

Finding alternatives to a “lockdown” approachWhile risk and risk management are among the most discussed issues at the board level of mining companies today, approaches to the identification, reporting and management of risks remain inconsistent. Companies in industries such as financial services are able to gauge their risks much more closely, and often, the jurisdictions in which they operate may even regulate key risks. Some of these companies are going so far as to publish formal statements that define their risk appetite and risk tolerances. This idea appeals to some mining company directors, but risk appetite is difficult to pin down

Project risk

Availability of labour

Community relations

Security and human rights

Fraud and corruption

Global financial conditions

Source: KPMG



in a mining context. For example, banks will use measures like VaR to monitor market and FX risk, and can set board approved limits for these metrics. Mining companies often do not have this luxury in an industry where geopolitical factors and commodity markets can change course in a week, and key risk metrics are not easily quantified.

However, there is another approach to risk management that that harks back to the early days of mining, where success often involved taking on risks others may avoid. As boards and management teams become ever more sophisticated in the area of risk, they are realizing that taking carefully considered actions can be an effective way to manage some of the uncertainty around achieving strategic objectives.

A 2012 Harvard Business School article by Robert Kaplan and Annette Mikes (1) discusses various non-traditional methods of controlling strategic and external risks. In their article, Kaplan

and Mikes suggest a framework for categorizing risks as preventable, external, or strategic. According to the authors, most preventable risks arise internally and should be eliminated or mitigated by traditional approaches. External risk is generally beyond a company’s control, including such events as a natural disaster, or a macroeconomic or geopolitical shift. Strategic risks occur when a company intentionally takes on calculated risk to pursue a particular reward or to achieve a strategic objective.

Taking actions to limit uncertainty around strategic objectivesSome companies have been using traditional risk management approaches mainly to focus on preventable risks, and this may have contributed to the bureaucratic feel of the exercise. However, there have been some interesting recent examples of risk-taking to pursue strategic objectives. Some are related to preserving value in companies and others are related to growing value.

Examples can be found in the current M&A markets. Over the past two years, M&A activity has receded to very low levels. The nature of the activity, however, is clearly related to a small set of strategic objectives. Asset sales have dominated activity as companies seek to improve the risk profile of their portfolios and generate cash for the balance sheet. (2)

(1) Source: Kaplan, R., & Mikes, A. Managing Risks: A New Framework. Harvard Business Review

(2) Source: KPMG



On the buy side, some companies are making strategic growth decisions for the future while also diversifying commodity risk and geopolitical risk. Often present in these deals are alternative sources of financing such as metal streaming contracts and private equity, as buyers are willing to give up some control to avoid overleveraging.

Managing projects is another area where risk has strong linkages to strategic objectives. Mining companies by their nature must undertake large capital projects to support production and generate revenue. We have recently seen some bold project approvals in the face of adverse times for the industry, and some equally bold project holds to re-evaluate their contribution to strategic objectives. When development projects are put on hold, there is a risk that contractual payments must continue on for goods and services such as supplies, labour and transportation. Some mining companies are making strategic decisions to negotiate flexible contracts, even at a cost, to remain nimble in this uncertain global economic and political climate.

The ability to remain nimble is also important for dealing with external risk as defined by Kaplan and Mikes. External risk can be the most difficult for mining companies to manage because it is usually beyond their control. Recently, mining executives

have been using words like “velocity” and “momentum” to describe a new suddenness and rapid progression of global events. Examples include:

• Recent diplomatic conflicts resultingin sanctions that create a volatilesituation day to day. An unfavourableaction by one country could suddenlyinterrupt foreign mining operations.

• Changing royalty and indirect taxregimens in some South Americancountries that may impact the viabilityof projects in various stages ofdevelopment.

• Instability in the political environmentof some African nations that mayimpact the rights to reserves and thesafety of those working at mine sites.

In some cases, the only way a mining company can hope to control the uncontrollable is by being nimble enough to minimize the impact.



ConclusionsThe bottom-up risk management process is not always a complete solution for the needs and culture of mining. Recognizing this, some mining companies are taking decisive action to manage the uncertainty around achieving their strategic objectives. Today, even in difficult market conditions, mining companies are willing to look for upside opportunities in a particular risk, and maintain a role for proactive risk-taking in their strategic toolbox. This attitude is consistent with the ethos of an industry that has been built on taking risks, and is likely necessary to protect long-term organization value. Strong top-down and bottom-up risk management processes are needed to ensure that mining executives and directors have the best information to make decisions affecting strategy.


Contact us

Anthony Bell Senior Manager Risk Consulting T: +1 416 777 3705 E: [email protected]

kpmg.ca/mining

The information contained herein is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavor to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act on such information without appropriate professional advice after a thorough examination of the particular situation.

© 2015 KPMG LLP, a Canadian limited liability partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. 8813

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Insights into Mining - KPMG corporate filings of five major Canadian mining companies ... as companies seek to improve the risk profile of their portfolios ... Insights into Mining