Risk Management asked a range of experts to comment on what they thought would be furrowing their brows in the year ahead, and what can be done to smooth the way
Regulators
Jennifer O’Donnell, executive director, compliance, Australian Securities and Investments Commission
Mitigating risks for retail investors; ensuring efficient capital markets; more in-depth on-site visits
Sound economic times have meant we are seeing confidence in our capital markets and, as globalisation increases, closer international cooperation. We are also seeing significant growth in direct retail investment.
On the flip side, we are seeing collapses in particular market sectors and more and more complex and sophisticated products aimed at retail investors.
In 2007, our chairman, Tony D’Aloiso, outlined the priorities that set the scene for ASIC’s work and will continue to do so through 2008.
Three of these focus on retail investors, capital markets and capital flows.
In 2007, we did a lot of work in the unlisted, unrated debentures market sector and will bed that down in 2008.
This year, our Retail Investors Taskforce, under the leadership of our deputy chairman, Jeremy Cooper, will look at risks for retail investors and specific issues that the advice industry continues to face, like the length of disclosure documents, compensation, remuneration arrangements and conflicts of interest. This will help us work out how to develop a more investment-wise retail sector better equipped to protect its wealth and with better access to quality advice.
The work of our Capital Markets Taskforce, under the leadership of commissioner Belinda Gibson, is aimed at maintaining and improving confidence in and integrity of our capital markets. We’ll focus on what additional actions we, in cooperation with the ASX, can take in the areas of continuous disclosure, market manipulation and insider trading. We’re also commissioning a study on the balance between corporate and personal liability under the current law.
In addition, we’re looking at ways we can facilitate the inward and outward flow of capital to ensure there are only the necessary minimum roadblocks to investment flows we need to keep the economy moving forward.
Our other three priorities are more internally-focused, but directed at making it easier for you to do business with us.
In compliance, we are enhancing our understanding of underlying business models and demonstrating that understanding in our regulatory approach. In the financial services industry, for example, we’re visiting 300 small to medium licensees to help them better understand our expectations and to help us develop a better understanding of them. We’re also visiting some licensees whose businesses have exhibited high growth to make sure their capacity and capabilities are keeping pace with their expanding businesses.
In practice, this will mean more compliance work onsite and fewer surveillance inspections by number, but in more depth.
We are currently carrying out a strategic review to work out where we need to be in the next three to five years. A key feature of this review will be a survey of external stakeholders, so I actively encourage you to provide input to this important initiative.
Dr John Laker, chairman of APRA
Bedding down Basel II; monitoring credit uncertainty; more efficient regulatory supervision
This year will see the last major plank of APRA’s recent reform agenda fall into place, when the Basel II framework is introduced. This fundamental reform of regulatory capital for deposit-taking institutions will provide stronger and more accurate management of and pricing for risk – a reward in itself for the investment incurred whatever the individual capital impacts prove to be. Other reform initiatives include conglomerates, refinements to the supervisory framework for general insurance to facilitate the licensing of foreign insurers, and further follow-up on the recommendations of the Regulation Taskforce.
In the current environment, financial institutions are facing a level of financial market uncertainty they have not had to confront for some period. The highly-unsettled state of global credit markets is expected to persist for a time, at least until the size and ownership of losses in the US subprime mortgage market becomes clearer and markets determine more prudent and sustainable pricing for risk. Though the global market volatility had its origins in poor lending practices and aggressive funding strategies by certain US credit providers, there are lessons for all financial institutions to learn in recent events. Boards and management need to satisfy themselves that risks in current and new ventures and investments are clearly identified and monitored, that incentive structures promote enduring rather than transitory success and that any greater appetite for risk is matched by robust risk management systems, the necessary skills and adequate capital resources.
Beyond its normal supervisory activities, APRA’s organisational energies in 2008 will be directed at further improving its efficiency and effectiveness. Importantly, APRA has strengthened its strategic focus on its supervisory processes and corporate infrastructure to ensure that their development is not piecemeal – hard to achieve in the formative period of a new organisation – but pursued within a comprehensive, best-practice blueprint. As part of this drive, APRA is also reviewing its supervisory cycles and the level of routine interaction with supervised institutions. APRA’s aim is to be well-placed to deal with changing economic currents, minimise unnecessary burdens on supervised institutions and make best use of its valuable staff resources.
APRA will also be working closely with ASIC to promote a balanced and efficient regulatory environment in the financial sector.
Compliance
David Lawrence, president Australasian Compliance Institute, and general manager of Participants in Market Supervision, ASX.
Greentape and aging population
I have been fortunate to gain an insight into a variety of businesses and organisations from a diversity of industry sectors and looking to the future, I can see two key challenges in the compliance field.
There is no doubt that environmental issues and the growth of “green tape” are here to stay. The inevitable growth in environmental regulation will result in a growing focus on environmental compliance. Initially, there will be errors and inefficiencies in legislation which the compliance profession will have to deal with and work to rectify and promote ongoing improvement. There will be increasing debate about governance and the disclosure issues arising from environmental risk and compliance (we are already seeing this in the US). The challenge for all of us will be managing the divergent focus by business upon the short term whilst the consequence of environmental non-compliance will often be long term.
The second area of challenge will arise from the aging population. This will bring an increasing focus on issues such as wealth management for the aged, aged health care and mental health care. These issues will have attached to them a significant personal and emotional involvement by the aged population and those who care for them. Issues such as this will inevitably attract political attention, especially in the circumstances of compliance failings. Hence, concentration on preventing compliance failings would be prudent in this sector. This should not be interpreted as suggesting that there are existing weaknesses, only that it will become an issue of increasing magnitude and resource growth in the compliance field.
Policy
Tom McDonald, board member of the Australian Risk Policy Institute
Business needs certainty on climate change regulation
The Australian Risk Policy Institute (ARPI) will be active in addressing the overall risk policy approach to regulation issues for business arising from policies announced by the new Federal Government. ARPI strongly supports the government’s announcement that it will deliver changes that provide certainty in business regulation. One such area where the stated policy will be critically important is business regulation with respect to climate change.
The landmark agreement in Bali last month has given the government a golden opportunity to apply its science- and evidence-based approach to business regulation in relation to climate change issues.
Cabinet clearly realises that applying legally binding targets will inevitably impact on Australian business. Hence, the government has quite rightly resisted taking a position until it considers the Garnaut report.
Why is this relevant to business risk management policy? Today, running a business encompasses very complex risk policy decisions in three distinct areas, all of which require correct judgement calls if the business is to succeed and prosper. The first involves the business itself, the second, audit and the third, compliance.
Audit and compliance are discrete areas that require separate elements of risk management strategy. Regulatory certainty is essential in order for those tasks to be carried out effectively. If either audit or compliance faces regulatory uncertainty, the overall risk management of the business becomes unbalanced and decisions cannot be made efficiently.
Investors today, particularly in the institutional area, such as pension funds, are looking at a values-based approach to investing. This entails adding environmental, social and governance (ESG) issues into their investment analysis and decision processes. Consequently, climate change expectations placed by government on business in terms of both audit and compliance are critical.
To be sure, not every business will face the same cost pressures in light of the government’s decisions. However, clarity of purpose and certainty in expectations will permit effective cost, price and governance decisions.
Mining
Tony Pooley, head of safety, environment and risk, Newcrest Mining
Critical year for risk professionals to win support
In 2007 our company went from an $8 billion market cap to more than double that. Much of that increase can be attributed to confidence in the new management team’s performance. It’s hard to know how much risk management’s more desirable sister ‘opportunity management’ has contributed to that success, but the risk process has certainly been used in considering major executive decisions throughout the year. The acceptance of the executive team that risk management is a fundamental management skill augers well for 2008.
One of my most enjoyable moments last year was a simple one. It came when we gained clarity in the definition of classifications in regard to risk management. After screening of all exposures for their potential consequences we found that we had, irrespective of what aspect of the business we were looking at, just three general categories of risk: material risks (where we believe a single outcome could seriously impact our stakeholders); compliance risks (where we do not believe there is a material risk but controls or activities are the subject of regulation); and non-material risks (where the benefit of managing the risk is likely to be greater than the cost.)
It is a strong belief of mine that one of the reasons risk management struggles to win support within many organisations is the chequered historical performance of risk professionals. This year could be a critical year in this regard and the RMIA’s fledgling Certified Practising Risk Manager program holds great promise. However, it needs traction and perhaps the direct involvement of Australian universities may further improve credibility and accelerate the acceptance of the qualification by practitioners.
Insurance
Tony Coleman, chief risk officer, IAG
New capital requirements; climate change
The insurance industry in Australia was confronted with a number of challenges during 2007, some of which will continue into 2008. The continuing soft cycle in commercial lines applied pressure on premium rates, making it difficult to maintain, on an accident-year basis, an adequate level of profitability and return on capital in this part of the market.
In addition, a number of severe weather events over the past year also impacted the industry with claims payments significantly exceeding normal allowances for bad weather. Such events provide further evidence of the likely future impact of climate change on communities and the insurance industry.
In the year ahead, APRA’s continuing efforts to evolve regulation governing the capital requirements for the Australian non-life insurance industry will have a considerable impact. These changes will significantly increase the minimum regulatory capital requirements insurers must retain during 2008 and add pressure to the industry’s ability to earn an adequate return on capital. APRA has also indicated additional changes are likely during 2008 which will impact capital requirements in later years. It is possible that APRA will be influenced by developments in Europe as the new Solvency II regulatory framework is finalised. This framework requires insurers in Europe to create a risk-sensitive economic model of their businesses so they can align their financial strength with a more accurate picture of their underlying risks.
Responding to these European developments, IAG and QBE have notified APRA they will be seeking formal approval for internal models to determine their capital requirements under the existing general insurance prudential framework. APRA has indicated such models could potentially be operational within 12 months, which could give some capital relief to the companies adopting this approach.
The ongoing focus by ratings agencies, such as Standard & Poor’s, on the quality of insurers’ enterprise risk management systems will also be a key theme in 2008.
The threat of US recession as a result of the subprime crisis will have a considerable impact on asset market risks in the year ahead. The flow-on effects of this crisis on investment markets generally may well have some impact on the capital position and the reported profitability of insurers in Australia during 2008.
IAG is particularly focused on ensuring the new federal government remains committed to taking the necessary steps to reduce greenhouse gas emissions to avert dangerous climate change and to adapt to the inevitable extent of climate change already “locked in” by existing emission levels.
Similarly, there is a growing recognition that sea level rises may make some waterfront properties uninhabitable or unfit for use in the future. Given the land value of all properties is currently uninsured, opportunities may exist for insurers to develop innovative ways to assist various stakeholders to manage the risk inherent in the potential loss of land value of such properties.
Advisers
Ron Loborec, national leader of enterprise risk services, Deloitte
Credit crunch, tight labour markets, lack of experience of economic downturns, infrastructure shortages and resources demand dampen possible recession, increased regulatory changes to deal with global warming
You can’t go past Centro Group. All I’ve seen happening both in our firm and a lot of our clients, is a lot of modelling is going on right now on the effects the credit crunch may have on global growth.
I now have a lot of clients saying to me that they have a labour force now that has never been through a recession. They’ve been able to innovate and think of new products and markets and how to expand and grow but maybe on this one they don’t currently have that experience. As well, I think labour markets [in general are a major risk]. I’ve yet to go through a year where things are getting better with labour markets. Things are getting, worse and worse and worse in terms of the ability to attract and retain talent … how to keep them engaged and the rest of it. That is a big risk for organisations that are growing.
The other one is broadly what I would describe as environmental. In the Australian context I think … the emissions trading scheme. I’ve seen a number of risks with this area. With the actual energy intensive sector, which – there's a very big client base in that -- and I think the new government are going to be more aggressive in terms of who’s included [under the national reporting requirements]. Transport and agriculture will be included very quickly I suspect. The Labor Government won’t change a lot in terms of the specific Bill (National Greenhouse and Energy Reporting Act), but they will be aggressive in terms of how quickly they want it to happen – the price of carbon, the allocation of permits and also who’s included. That’s what I mean, it’s those three dimensions to [the new government’s] aggressiveness that I think people should be really thinking about modelling and forecasting.
I think if you look at the flipside of risk, which is opportunity, many of our clients now are experiencing incredible growth in innovative market segments by looking at the flipside of the environment and climate change and targeting the markets they should be entering into now.
The other area would fall broadly under the heading of ‘delivery’. Through most of the scenarios I’ve looked at, the one thing that might recession-proof Australia, and Asia-Pacific to an extent, is our infrastructure sector. The continued strong demand across the globe particularly from India and China, give a little bit of weatherproofing to this part of the world, so that even though a recession may occur over the next four or five years … we may only be talking of a minor percentage point impact on Australia, to the extent that we can deliver it. So we get a lot of businesses that have a delivery component of infrastructure projects, particularly on the government’s side. Mechanisms like [public-private partnerships]. How the private sector prices its risks and transfers that between itself and the government sector, and I think that’s a really big area over the next decade. We are seeing that a lot now, with the energy assets in NSW being put on the market.
Julie Coates (partner) and Alan Hui (director), PricewaterhouseCoopers
Risk management for competitive advantage
Over the next 12 months, risk management in the non-financial services sector will be fundamentally tied to the growth challenges and the increasing complexity of doing business in a faster, more integrated global economy.
It is a year in which we’ll see risk management return to focussing on the drivers of business success: strategy, people and resilience to weather unforeseen changes in the external market such as the credit crunch in 2007. There will be winners and losers.
The challenges for businesses in the non-financial sector in 2008 will be closely linked their ability to extract value from risk management activities and investments over the next 12 months. In meeting these challenges there are three areas businesses need to focus on:
1. Taking the right risks – strategy and uncertainty: The demands for earnings growth and returns for risks taken by management provide risk management professionals with an opportunity: reduce the level of uncertainty with strategic choices or develop risk management options to ensure strategic objectives and investment targets are achieved.
Risk professionals can now leverage the credibility and success in operational risk and compliance to meeting these challenges. Key to success will be to recognise that you may need different skills, capabilities and relationship skills to engage in these strategic and investment conversations and decision making forums.
People make decisions ? behaviour and culture. Risk management will continue to focus on improving process and technology. Efficiency and effectiveness of embedded risk management practices in operational routines will drive simplicity and greater ‘customer experiences’.
The challenge in the next year is to leverage the gains from process improvement and efficiency to influencing and driving the appropriate risk management behaviour and culture in the organisation. This is where the greater return on ‘risk effort/investment’ will be gained.
2. Agility and resilience, responding to crisis: Numerous events in 2007 demonstrated management’s need to anticipate and manage confidently and quickly in times of crises. These events included the credit crises, private equity and hostile takeovers and regulatory changes. The boom times may be over.
Business needs to continually assess its financial and operational resilience to shocks. Risk management professionals will be critical to providing the experience and disciplines in which to evaluate the organisation’s risk profile, its risk appetite, and the organisations risk tolerance/capacity to withstand risk exposures and crisis under different scenarios. You do not want to be around when the questions gets asked ‘… but where was risk management?’
Governance
Lynn Ralph, company director and managing director of Cameron Ralph
Governance under closer scrutiny by investors
After six positive years of sharemarket returns, investors have now been confronted with two major corrections, and two notable collapses – Westpoint and Centro Properties.
In the cold hard light of substantial falls in value, investors who had, for the most part, put less focus on governance practices over the past four years (a few notable stoushes over CEO remuneration aside), will now be having a much closer look at how boards are operating. The ‘if not, why not’ explanations of boards which fail to satisfy the ASX corporate governance principles may come under much greater scrutiny and a lot less ‘forgiveness’.
Falls in market value combined with some stabilisation in the credit markets may bring out the predators again. The ongoing focus of both shareholders and media on escalating executive compensation will not abate and shareholder activism will further extend into ever-increasing investor class actions.
All of this will be played out under a new government with new policies and legislation to be enacted.
During 2008, boards will face not only a tougher, less-forgiving environment but also some of the most complex, long-term challenges their company will ever face in identifying and managing the risks associated with climate change.
What can boards do to ensure they maximise their performance in the face of a difficult year? Firstly, boards should be revisiting their composition via formal succession plans to ensure their directors are up to the task ahead. Boards need to align their composition with the long-term strategy for the organisation, not merely assume that past success will guarantee future success.
Experience in dealing with mergers and acquisitions, and risk management will become highly-valued skills to have around the table. Secondly, boards should revisit how they are spending their time. Almost all boards complain that they do not spend enough time on strategic issues. Finally, boards should regularly review whether they are maximising their value add to the organisation.
Professor Michael Adams, head of the law school at the University of Western Sydney
Good progress on governance in Australia.
This year will see corporate governance continue to be a major discussion point around the board tables of Australia. In September 2007, a research team at the Centre for Corporate Governance at the University of Technology, Sydney (UTS), including Professor Thomas Clarke, Alice Klettner and myself, released the results of three years examining the extent to which the Australian corporate governance reforms have caused changes at a practical level within companies. The study, entitled The Changing Roles and Responsibilities of Company Boards and Directors, was focused on qualitative changes in thinking and behaviour. The ultimate aim of the project was to discover how corporate governance might add value to companies, both in terms of accountability and performance.
The positive note of the research was that in light of the changes made by companies, it considers whether Australia has found the right balance in its corporate governance regime. On the basis that both the costs and benefits are difficult to precisely pin down, it is not an easy balancing act to achieve. Nevertheless, Australia appears to be on the right track in terms of developing a useful and well-balanced corporate governance system
Across all sectors of Australian business surveyed there was evidence of intelligent engagement in corporate governance and professionalism in its implementation. To a degree this may have been a reflection of the interest in corporate governance of the companies and interviewees, the majority of whom demonstrated themselves to be highly-informed directors, company secretaries and legal counsel.
The research clearly revealed that the corporate governance practices appropriate for a company change as the business grows and develops. The governance needs of start-ups and small enterprises are very different from those of mature ASX 100 companies. The role of the board and directors changes over time and board composition ought to reflect the needs of the company rather than conforming to any particular formula.
Security
Jason Brown, ASIS International vice-president, Australia, and RMIA SSIG chairman
Since its publication in late-2006, the Standards Australia and Standards New Zealand’s Security Risk Management handbook (HB 167: 2006), based on 4360 processes, has gained significant traction. This, together with the imminent publication of the Security Risk Management Body of Knowledge (SRMBoK) by RMIA, will set the stage in 2008 for increased integration of risk management into the practice of security.
The SRMBoK will help both specialist security and generalist practitioners in the management of risk to answer questions like: What does it take to create a secure environment?; how should I determine the risks facing my organisation?; and how do I implement an effective framework for governance?
The SRMBoK is intended to become a pivotal reference document which brings together a range of security domains, methodologies and disciplines to provide a single source toolkit and reference ‘bible’ for consultants, managers, students and practitioners alike.
This integration of risk management and security practice is going to be supported by ASIS International and RMIA, who have developed a memorandum of understanding for cooperation between the two organisations.
ASIS, with 36,000 members worldwide, has recently formed a chapter in Canberra which will have a particular focus on developing security professionalism and linkages with government. ASIS and the RMIA Security Special Interest Group (SSIG), together with the Australian Institute of Professional Intelligence Officers will hold eight seminars at the Australian Defence Force Academy throughout 2008.
On the national front ASIS and RMIA SSIG will cooperate with Australia’s National Centre for Security Standards in developing Australian security standards.
Business continuity
David James-Brown, director of JBTGlobal Corporate Advisory and fellow of the Business Continuity Institute.
Business continuity management (BCM) continues to be ‘discovered’ year on year by different industries and sectors. The finance sector, a long-time convert to BCM, is being joined by manufacturers, telecommunications providers, governments and others.
Early advocates – Europe, the US and Australia – are being joined by Asian countries as the benefits are recognised and translated into the specific business cultures for those regions. BCM is not the overhead it was once considered; far from it. The best performing businesses are often those that invest heavily in strong governance and specifically BCM. Therefore, what was once a compliance driven chore is becoming an essential tool of commercial advantage. Efficient ‘just in time’ global business is placing stringent demands on the supply chain and requiring participants to demonstrate their resilience. Insurers are apportioning premiums that consider demonstrated BCM capability.
Globalisation has had the effect that even geographically constrained events such as the US subprime lending crisis send ripples through the global economy. Organisations now carry exposures from all over the world, even in markets in which they don’t operate.
This increased attention on BCM calls for the deployment of more practical and efficient education, tools and methods. The theoretical and often rambling methodologies that have marked the rise of BCM are being forced aside by no-nonsense, time-effective and output-focused BCM implementations.
Our challenge in 2008 will be to ensure our training is increasingly measurable by vocational outcomes and that our BCM programs deliver straightforward and rapid results.
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