Looming IFRS Risks Pose Significant Challenges

More and more companies are beginning to examine the potential impact of the imminent conversion from U.S. Generally Accepted Accounting Principles ("GAAP") to the International Financial Reporting Standards ("IFRS").  The big difference between the two sets of standards is the fact that GAAP is primarily "rules-based", while IFRS is "principles-based".  The nature of a more principles-based set of standards adds to the amount of interpretation and risk in financial reporting.   Here is what an article in September 2009 issue of the Journal of Accountancy recently noted on the emerging risks from IFRS implementation.

Conversion to IFRS will be far more than a technical accounting exercise. Implementing IFRS will impact many, if not all, aspects of your business operations. It may bring companywide changes that will spawn new risks. These include system changes, modifications to processes impacting employees’ day-to-day duties, and new accounting policies.

Companies will also need to evaluate the impact these differences may have on their accounting policies, as well as the underlying information technology systems that support the company’s financial reporting structure. Changes to policies and systems on this scale will invariably give rise to additional risks that your organization may need to monitor and control.

The move to IFRS represents a huge opportunity for global companies to streamline their financial reporting, while at the same time poses major risks in the quality of implementation across the organization.  Wheelhouse Advisors can help your company analyze the IFRS related risks and provide solid expertise to support a successful implementation. Visit www.WheelhouseAdvisors.com to learn more.

Common Objectives of the Chief Risk Officer & Chief Audit Executive

John A. Wheeler of Wheelhouse Advisors delivered a presentation this week at the 2009 Institute of Internal Auditors Conference in San Diego, California.  His presentation focused on the common objectives of the Chief Risk Officer and the Chief Audit Executive in today's perilous global economy.  Key discussion topics included:

1. Learning about the evolving role of the Chief Risk Officer (“CRO”) both before and during the current global economic crisis


2. Developing an understanding of the complementary aspects of the CRO and Chief Audit Executive (“CAE”) roles, as well as the potential conflicts to avoid


3. Discovering strategies and critical success factors for an effective CRO & CAE partnership

Given the increase in both complexity and interrelationships of risks across corporations, an effective relationship between these two executive roles and their organizations is vital.  Wheelhouse Advisors provides cost-effective solutions to enable strong relationships in support of robust ERM programs.  To learn more, visit www.WheelhouseAdvisors.com.

Looking to Satisfy Risk Management Demand

Companies are now beginning to shore up their risk management practices and are hiring more risk management professionals as a result.  An article in the New York Times this week discusses the increase in demand for risk management skills and how prominent business schools are preparing graduates for the field.

Among the hot areas now are positions related to minimizing risk, as firms try to mitigate the chances of another financial crisis. Risk in general is a relatively new focus, and the openings range from business, credit and operational risk to product and technology risk. “Risk is everywhere,” said Jeanne E. Branthover, head of the global financial services practice at Boyden Global Executive Search.

This year, the Stern School of Business at New York University started offering an executive master’s in risk management in partnership with the Amsterdam Institute of Finance. During the program, which lasts a year and costs 42,000 euros, or about $60,000, students meet 10 times for multi-day sessions and study subjects including risk metrics, credit risk and liquidity risk. The course covers about 75 percent of what one is required to know for the professional risk manager certification, said Ingo Walter, a professor of finance at Stern.

Stern also offers a less technical three-day executive education session on integrated risk management. Columbia Business School and the Kellogg School of Management at Northwestern University are among other institutions that offer similar programs, which range in cost from $3,750 to $10,000.

As more business school graduates with a foundation in risk management enter the corporate world, corporations will certainly benefit from having these skills proliferate throughout the organization.

New Study Proves ERM Provides Significant Value

In what may be the first study to measure the value of Enterprise Risk Management ("ERM") programs, researchers from the University of Georgia and the University of Mississippi have determined that effective ERM programs can deliver a 16.5% premium in overall company value.  Here is what they have to say about contributing factors to the increase in value.

Firms that engage in ERM are able to better understand the aggregate risk inherent in different business activities. This provides them with a more objective basis for resource allocation, thus improving capital efficiency and return on equity. A further source of value from ERM programs arises due to improved information about the firm’s risk profile. Outsiders are more likely to have difficulty in assessing the financial strength and risk profile of firms that are highly financially and operationally complex. ERM enables these financially opaque firms to better inform outsiders of their risk profile and also serves as a signal of their commitment to risk management. By improving risk management disclosure, ERM is likely to reduce the expected costs of regulatory scrutiny and external capital.

In a challenging economic environment, this study proves that companies will be well served to invest in effective ERM programs.  Not only will companies realize an increase in value, but will gain a significant competitive advantage that will drive longer-term increases in value.  Wheelhouse Advisors specializes in building ERM programs to help companies achieve these advantages.  To learn more, visit www.WheelhouseAdvisors.com.

The Credit Risk Paradox

In this month's issue of Treasury & Risk Magazine, the dramatic increase in credit risk at financial and non-financial companies is examined.  As strategies to mitigate credit risk become more sophisticated, a paradox ensues.  Rather than lowering the amount of credit risk, the strategies can have the opposite effect because they provide a false sense of security.  Here is what the article concludes.

On a macroeconomic level, the dramatic rise in credit risk is partly a result of the very success of credit risk mitigation tools and strategies, argues Jerry Flum, CEO of CreditRiskMonitor in Valley Cottage, N.Y. “We’ve done a lot to promote stability and off-load risk, but the more risk companies transfer, the more they leverage up. When you hedge credit risk with derivatives, you feel confident in taking on more debt.”

The illusion of safety achieved by theoretically reducing risk has encouraged companies to take steps that increase the consequences of negative developments. “Because the foundation seems stable, you build a skyscraper,” Flum says. “It’s rewarding but catastrophic when it falls.” Whether and how the skyscraper will be rebuilt will be a big issue for treasuries of the future.

The big question is how many skyscrapers with weak foundations are looming out there?  Periodic credit stress tests can help provide a better view of the skyscraper and how their foundations can be strengthened.

New Rules Require ERM Disclosure

The U.S. Securities and Exchange Commission ("SEC") recently proposed rule amendments that may have a profound impact on not only the disclosure of corporate governance practices, but also the enterprise risk management ("ERM") practices at major U.S. corporations.  The rule amendments are available for comment until September 15, 2009 and could be finalized soon thereafter.  Here is a portion of the rule amendment relating specifically to enterprise risk management.

We also are proposing to require additional disclosure in proxy and information statements about the board’s role in the company’s risk management process. Companies face a variety of risks, including credit risk, liquidity risk, and operational risk. Similar to disclosure about the leadership structure of a board, disclosure about the board’s involvement in the risk management process should provide important information to investors about how a company perceives the role of its board and the relationship between the board and senior management in managing the material risks facing the company.

Given the role that risk and the adequacy of risk oversight have played in the recent market crisis, we believe it is important for investors to understand the board’s, or board committee’s role in this area. For example, how does the board implement and manage its risk management function, through the board as a whole or through a committee, such as the audit committee?  Such disclosure might address questions such as whether the persons who oversee risk management report directly to the board as whole, to a committee, such as the audit committee, or to one of the other standing committees of the board; and whether and how the board, or board committee, monitors risk. We believe that this disclosure will provide key insights into how a company’s board perceives and manages a company's risks.

Disclosure such as this will require changes for companies that may not have an effective enterprise risk management program in place.  Wheelhouse Advisors is uniquely qualified to help companies build effective ERM programs that are practical and business-focused.  Visit www.WheelhouseAdvisors.com to learn more.

Regulating Financial Weapons of Mass Destruction

The Obama Administration unveiled its proposed regulatory legislation for derivatives yesterday.  This legislation is the centerpiece of the financial regulatory overhaul due to the role derivatives played in the recent economic meltdown.  The new legislation to be considered by Congress aims to prevent future abuse of derivatives and, as a result, decrease the systemic risks posed by these markets.  Here is a summary of the goals of the legislation.

As part of the Administration's proposed legislation, credit default swap markets and all other OTC derivative markets will be subject to comprehensive regulation in order to:

1. Guard against activities in those markets posing excessive risk to the financial system


2. Promote the transparency and efficiency of those markets


3. Prevent market manipulation, fraud, insider trading, and other market abuses


4. Block OTC derivatives from being marketed inappropriately to unsophisticated parties

These goals will be reached through comprehensive regulation that includes:

1. Regulation of OTC derivative markets


2. Regulation of all OTC Derivative dealers and other major market participants


3. Preventing market manipulation, fraud, insider trading, and other market abuses


4. Protecting unsophisticated investors

While the goals are clear, the methods to regulate are less so.  Responsibility for enforcement of the new regulations will be assigned to multiple agencies and may over time prove to be less than effective.  Warren Buffett famously described derivatives as "financial weapons of mass destruction".  Given the size and magnitude of the markets to be regulated, the accountability for enforcement should be strengthened to ensure proper oversight of these potentially deadly securities.

Managing Risk to Stay on the Successful Path

A recent study by Accenture indicates that many large corporations across the globe are looking to improve their risk management capabilities as a result of the recent economic crisis.  The study included a survey of more than 250 companies to determine the current state of risk management practices.  Here is a summary of the findings.

About half of the respondents believed that their company was well prepared to face the current level of economic turmoil. More than 85 percent of respondents indicated that their risk management capabilities needed to change. Forty-two percent of respondents pointed to the need for better integration of risk, finance and business data. Eighty percent of respondents say that poor data quality, inefficient reporting and fragmented systems are increasing the cost of risk management. Risk managers spent only 20 percent of their time advising business units. More than 70 percent of respondents have increased or plan to increase spending on risk management.

Do these findings mirror the current state of risk management at your company?  If so, Wheelhouse Advisors can design a cost-effective program to put your company on the path to success.  Visit www.WheelhouseAdvisors.com to learn more.

Demand for CROs on the Rise

Chief Risk Officers are beginning to make their mark in industries other than financial services, according to a recent article by Lloyd's.  Many of these new positions will need to be filled by risk managers that may not necessarily have the full complement of skills that their financial services peers may possess.  Here is what Lloyd's and a seasoned risk management practitioner have to say about the issue.

In these times of economic uncertainty, with risk management increasingly recognised as a core competency, insiders now expect CROs to start appearing in major industry sectors outside financial services.  Some insiders have questioned whether risk managers, who traditionally have a background in operational issues, have the necessary financial skills to make the transition however. Joe Restoule, president of the US risk manager association the Risk & Insurance Management Society (RIMS), thinks not.

Restoule, who is in charge of risk management at NOVA Chemicals Corporation, thinks that those risk managers that have embraced enterprise risk management (ERM) have by necessity become more financially savvy.  “It isn’t widespread yet but I sense that risk managers are certainly aspiring to ascend to the CRO position. Risk managers have to be more financially focused because there is so much emphasis today on liquidity and solvency—in terms of their own business but also in terms of the insurers they must deal with,” he says from his office in Calgary, Canada. “So we’re getting better all the time at using the tools to manage these financial risks.”

As more companies adopt an Enterprise Risk Management approach, qualified candidates for the new CRO role will emerge.  It is only a matter of time.

CEOs & CFOs Beware: SOX is Clawing Back

For those that thought the Sarbanes-Oxley Act ("SOX") is now just a relic of the past, think again.  Section 404 of the Act required massive investments by large companies to bolster their internal controls over financial reporting.  However, another section of the Act, Section 304, is just now starting to be utilized by the Securities and Exchange Commission ("SEC") as an enforcement mechanism to "clawback" executive pay.  Here is the language from Section 304 in its entirety.

Section 304 -- Forfeiture of Certain Bonuses and Profits

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1. Additional Compensation Prior to Noncompliance With Commission Financial Reporting Requirements. If an issuer is required to prepare an accounting restatement due to the material noncompliance of the issuer, as a result of misconduct, with any financial reporting requirement under the securities laws, the chief executive officer and chief financial officer of the issuer shall reimburse the issuer for--
   
   
   
   1. any bonus or other incentive-based or equity-based compensation received by that person from the issuer during the 12-month period following the first public issuance or filing with the Commission (whichever first occurs) of the financial document embodying such financial reporting requirement; and
   
   
   2. any profits realized from the sale of securities of the issuer during that 12-month period.
   
   
   
   


2. Commission Exemption Authority. The Commission may exempt any person from the application of subsection (a), as it deems necessary and appropriate.

The wording of the legislation is not specific as to who should forfeit their compensation when a company is found to have misstated its financials.  As a result, the SEC is targeting the CEOs and CFOs of these companies regardless of their involvement in the wrongdoing.  The first enforcement action is against the CEO of CSK Auto Corporation and seeks $4 million in restitution from the CEO.   Here is what the SEC alleges in their action.

"The personal compensation received by CEOs while the companies they serve engage in wrongdoing can be clawed back," said Robert Khuzami, Director of the SEC's Division of Enforcement. "The costs of such misconduct need not be borne by shareholders alone."

"Jenkins was captain of the ship and profited during the time that CSK was misleading investors about the company's financial health," said Rosalind R. Tyson, Director of the SEC's Los Angeles Regional Office. "The law requires Jenkins to return those proceeds to CSK."

According to the SEC's complaint filed in U.S. District Court for the District of Arizona, Jenkins made $2,091,020 in bonuses and $2,018,893 in company stock sales that should have been reimbursed to CSK pursuant to SOX Section 304.

This action is proof that the risks associated with compliance and regulation are increasing and are very real.  Are you certain that your company is SOX compliant?  If not, Wheelhouse Advisors can help.  To learn more, visit www.WheelhouseAdvisors.com.

Regulatory Brouhaha Erupts

The Wall Street Journal reported last week that Treasury Secretary Timothy Geithner is apparently fed up with the infighting amongst the various federal agencies vying for turf in the proposed financial regulatory reform package. Here is a brief video detailing the brouhaha.

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