Wednesday, November 16, 2011

Structured approach to risk management

Globalization, tighter regulatory requirements and increasing shareholder involvement have re-defined the nature of risks faced by organizations.  As business environment is becoming more and more competitive and complex, boardroom discussions increasingly dwell upon internal control and risk management as effective tools to survive and excel. 

Market risk management is an important aspect of business and appropriate attention to this ensures that volatile financial markets don’t result in volatility in financial performance of an organization.  It is imperative to understand how market changes (changes in currency, commodity and interest rates) affect businesses, in order to plan and react quickly to events. It needs no further emphasis that market risk management is pivotal to running a business efficiently.  Let’s take a quick look at important ingredients of sound risk management:

Firstly define Objective. Sounds obvious, right?  In reality, it is often unclear whether an organization is looking to out do market or protect its budgeted rates or avoid accounting losses or run its treasury as a profit centre or a mix of some / all of the above.  Setting objective / benchmark to measure performance is first step to managing risk proactively.

Approach to managing risk should be arrived at, after careful consideration of various aspects viz (1) organization’s risk tolerance (2) how to gauge exposure and risk (3) historical simulations (4) stress / scenario testing (5) why should the exposure be hedged (6) when and what should be hedged (7) cost of hedging (8) internal resource availability (people, skill, systems& bank limits), (9) management commitment etc. 

Strategy: (a) management style (Is it going to be one of dynamic? all or none (100% or 0%) hedge? net or gross exposure management? based on cost of trade finance?) (b) define internal authority on hedge decisions (c) products (forwards, options, swaps) / tenor and approval matrix (d)  MIS and escalation process (e) front office / back office segregation (f) whether external expertise to be sought for day-to-day decision making? and so on.

Monitoring and Control: Monitoring indicates performance measurement. It helps identify gap in resources, training / system needs etc. More importantly, monitoring and control ensure compliance and enable periodical fine tuning of strategy and adapt to changing business environment.  Corporate risk management is a process, after all.

Risk Management Framework / Policy documents all of the above and disciplines risk management practice. A board approved policy is the best form of communication to all stakeholders on how risk is being approached and mitigated.  Increasingly regulators and financial institutions derive huge comfort from a corporate customer with a structured approach to risk management.

POIESIS risk solutions would partner with your organization to help you effectively manage market risk.  Our service is customized to suit your current preparedness, individual needs and would be tailored to tackle key risk management challenges.

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