Enterprise-wide Strategic Risk Management
Ashish Goenka & Pankaj Lunawat

The most advanced companies are evaluating and quantifying their risk and performance on an enterprise-wide basis. They do this not only to best control losses and manage risk firm wide but also to create a competitive advantage in the market place. They integrate enterprise-wide risk management into both their strategy and their culture.

Enterprise-wide strategic risk management is a multi-staged process that begins with the quantification and timely reporting of the total risk in the overall firm. This includes quantification of market (including currency and interest rate), credit, liquidity, and operational risks.

Limitations on the amount and type of risk carried by the firm are then established and are a function of the capital available to the firm and the firm's strategic goals. These are typically expressed as Value at Risk, Earnings at Risk, or Profit at Risk limits.

The risks in the overall firm are then adjusted to bring them in line with the parameters or limits defined by the firm's strategic goals. The risk in the firm is then monitored, quantified, and corrected on a daily or weekly basis to ensure that the risk profile of the firm remains aligned with the strategic vision of the firm.

Stress testing of the overall firm's or division's risk portfolio is completed routinely to ensure that the assumptions underlying the strategy remain sound. Periodic risk-adjusted performance evaluations are completed to ensure that the risk capital allocated to each business is earning the minimum targeted risk-adjusted returns. If not, it should be reallocated to areas where it can earn higher risk-adjusted returns. Periodic re-calibration of limits should occur as strategy or business circumstances evolve.

The major benefits of this approach are twofold:

1. Timely, accurate, and comparable quantitative, enterprise-wide risk information is communicated to senior management, allowing for comparatively rapid risk management decisions to be made. In this way, losses can be minimized.

2. Scarce and expensive capital can be allocated to the areas of the firm that produce the highest risk-adjusted returns over the long term. This enhances shareholder value, smoothes earnings volatility, and can lower the firm's cost of capital creating a competitive advantage.

The role of the treasurer…
Corporate treasurers are in the best place in the organisation to implement enterprise-wide strategic risk management systems.

1. With the ongoing evolution of the treasury function towards a regional or head office function, information flows needed to quantify risk are increasingly flowing through the treasury.

2. Treasuries are in a unique position to minimise hedging costs by hedging exposures on a larger scale due to their ability to quantify exposure for the entire enterprise.

3. Their involvement in the financial markets and access to market information makes them best able to develop credible and realistic scenarios for stress testing the portfolio.

4. The treasurer's access to senior management gives him/her the ability to deliver pertinent and timely risk information to senior management so that strategic risk decisions can be made before losses occur.

5. The capital allocation decision has long been a function facilitated by treasury for the CFO. This function will be enhanced by treasury's ability to recommend capital allocations on a risk-adjusted performance basis.

6. A computer system and the Value at Risk (VaR), Cash Flow at Risk (CFaR), or Risk Adjusted Return on Capital (RAROC) numbers it can produce are only as good as the people who use them.

Integrating Cash and Treasury Management…

Hedging strategies have already helped to fuse the once discrete disciplines of cash and treasury management. That the risks of incurring large losses on uncovered positions have become apparent at the same time as the risks of losing access to credit lines may have been an accident of the regional financial collapse. That the treasurers have been forced to focus more on improving operating efficiencies - through enhanced liquidity management - and rationalising costs may similarly have been by-products of recession.

Whatever the case, the requirement to deal proactively with inherently more risky market conditions has accelerated the combination of cash and treasury management skills for the more discerning treasurer. The convergence has been all the quicker now that the quick and efficient collection of foreign currency receivables, for example, has proven to be an effective risk management and hedging tool in and of itself.

It is a combination that has long been acknowledged and developed in the US and Europe, where the revolution of economic cycles has been both quicker and more pronounced in modern times. It has perhaps been unsurprising, as a result, that MNCs have been at the forefront of reconfiguring their Asian cash and treasury operations.

Companies that might previously have considered devoting resources to their Euro and year 2000 issues ahead of addressing cash and treasury systems and solutions in Asia have quickly moved the latter to the top of their internal agendas.

Simultaneous to this development has been the realization that the high level of autonomy once accorded by MNCs to cash and treasury operations may no longer be acceptable in the new environment.

It Pays to Centralize…

Hand-in-hand with this consolidation has been the push towards a centralization of the cash and treasury management functions into one regional treasury centre (RTC). They promise greater cost savings and efficiencies in terms of transaction processing, administration and taxation.

MNCs that once only talked about establishing an RTC have begun to turn words into action as a result. Regional corporations, which have embarked on broad-based restructuring programmes, are similarly factoring the need for greater treasury management capabilities into these efforts almost as a matter of course.

Both have found that the often-fierce resistance to centralization that could have been expected from local entities in the past has become both less marked and easier to circumvent. The more protective local fiefdoms - whether sales, manufacturing or treasury-related subsidiaries - have certainly found to their cost that restructuring can also mean streamlining and downsizing.

It is axiomatic that risk management is only possible and effective on a regional basis if cash flows and exposures are known entities. Both the implementation of enterprise systems to capture data and their interface with electronic banking systems to enable the real-time monitoring and management of risk are becoming standard requirements for the sophisticated treasurer as a result. The benefits available to those who centralise all treasury functions in order to police these risks are increasingly apparent.

Things to Do: A Checklist..
The following is a checklist of recommendations for treasurers. It serves as a rough and ready guide to the most pressing risk management issues. We recommend treasurers consider:

1. Establishing a risk management policy that mirrors but does not necessarily attempt to replicate international standards (to allow for regional inconsistencies). This should incorporate a hedging strategy that is fully communicated to all members of the treasury;

2. Paying the premium to obtain credit facilities of a committed nature and from a reputable (and, where possible, rated) service provider;

3. Spending time to negotiate documentation that reflects the nature of particular loans. It is dangerous to assume a committed credit line is in place if clauses in the documentation enable the lender to withdraw at the first sign of trouble;

4. Matching funding liabilities to the nature of the underlying assets or activities; converting some short-term debt costs into long-term fixed rate funding;

5. Hedging foreign exchange risks even if the forward points appear unfavourable. Where currency restrictions exist, the use of non-deliverable forwards should be examined;

6. Implementing cash sweeping or pooling system. This will enable the offsetting of low returning credit balances against potentially expensive short-term debit balances, thereby reducing interest expenses; and

7. Establishing systems to identify overdue receivables and appropriate procedures to pursue debtors at the earliest signs of trouble. Credit checks on trading partners should be standard business practice and be performed at regular intervals.

Do You Have a Risk-aware Management Culture?
Having all the risk management systems in place will not protect a firm or enhance its performance unless it is embedded in a risk-aware corporate culture. A risk-aware corporate culture considers risk hand-in-hand with return and uses the information made available by a risk management system to manage risk and make strategic decisions.

The following questions can help to determine if a firm is sufficiently risk aware.

Can the firm quantify its market, credit, and operational risk exposures on an enterprise-wide basis in a timely manner?

• Does it identifies and addresses the risks of significant revenue fluctuations due to market fluctuations?

• Does the firm determines its Cash Flow at Risk, or Earnings at Risk?

• Does it take a proactive approach to monitoring, managing, and controlling its foreign exchange, interest rate, credit and operational risk?

• Does the firm considers the impact of market risk on the credit risk of its buyers or trading counter parties?

• Is performance evaluated in part on a risk-adjusted basis?

• Are the firm's strategic goals expressed in terms of growth, profitability and risk?

• Does the firm have developed contingency funding plans?

• Does the firm take an enterprise-wide approach to hedging its exposures?

• Does the firm conduct stress testing of its businesses?

• Does it use risk limits to implement and monitor progress towards strategic goals?

• Does it allocate capital on a risk-adjusted basis?

• Is there a risk management function within the firm?

• Does the firm have policies in place for controlling risk?

If the answer to any of these questions is 'No', the firm may not be realizing its full potential and may be seriously exposed in the event of a round of international financial turmoil.

Intelligent and controlled risk-taking that rewards the firm proportionately for the risk it is taking is the hallmark of a risk-aware corporate culture. A firm that has such a culture will be properly rewarded for the risk it takes. If the firm keeps its risk profile in line with its risk appetite, it will achieve its long-term strategic profitability and growth goals and so enhance shareholder value.

Ashish Goenka & Pankaj Lunawat
MBA (IB), 2^nd year
Indian Institute of Foreign Trade (IIFT)
School of International Business Management
Email: ashishgoenka_iift@yahoo.com

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