Harvard Professor Agrees that Companies Need a Risk Scorecard

Earlier this year, Harvard professor Robert Kaplan (the originator of the Balanced Scorecard used by many companies in setting strategy and managing their businesses) sat down for an interview to discuss how companies can learn from the latest financial crisis. His answer to an inquiry into what has been lacking at companies is quite interesting and consistent with the thoughts of this blog. Here's what he had to say.

If I had to say there was one thing missing that has been revealed in the last few years, it's that there's nothing about risk assessment and risk management. My current thinking on that is that I think companies need a parallel scorecard to their strategy scorecard - a risk scorecard. The risk scorecard is to think about what are the things that could go wrong? What are hurdles that could jump up, and how do we get early warning signals to suggest when some of these barriers have suddenly appeared so you can act quickly to mitigate that. [Risk management] turned out to be an extremely important function that was not done well by many of the [financial services] companies we talked about earlier. Risk management was siloed and considered more of a compliance issue and not a strategic function. Now we see that identification, mitigation and management of risk has to be on an equal level with the strategic process.

Professor Kaplan is right on point with what is needed today by companies in the complex, globally competitive world we live in. Wheelhouse Advisors has developed The ERM Compass™- a simple, straightforward roadmap for companies looking to develop a risk scorecard. If you are interested in learning more, please email us at NavigateSuccessfully@WheelhouseAdvisors.com.

ERM Focus is Global

The increasing emphasis on enterprise risk management (ERM) in the wake of the latest financial crisis is global.  As evidence, the Institute of Actuaries of Australia conducted a survey last week on ERM practices with the following results.

The online Enterprise Risk Management (ERM) survey was conducted by the Institute of Actuaries a week before its ERM seminar held in Sydney yesterday. It showed that while more than 85 per cent of respondents, comprising senior financial services executives, actuaries and risk managers, revealed a heightened awareness of risk management, they still saw weaknesses in a number of risk management areas.

Some 60 per cent said the area of most improvement was reporting at board level, 50 per cent stated the greatest improvement was in risk governance processes and 50 per cent stated that the risk culture had changed and people were more likely to speak up about possible risks.

As companies and individuals become more interconnected across the globe, this added emphasis on ERM is critical in helping avert a crisis as severe as the last.

Boards Take the Lead on Risk Management

The Conference Board published a report this month about best practices in public company risk oversight. The report compiled interview insights from  20 members of U.S. public company boards, representing a variety of business sectors (including manufacturing, high tech, real estate, food services, retail, telecommunications, air travel, energy, health care, and banking) and ranging in size from $150 million to over $30 billion in revenues. The report ultimately demonstrates the need and desire of corporate boards to take the lead in improving risk oversight. The following ten insights are noted in the report with actual board member quotes in italics.

1. Assign the responsibility of risk oversight to the full board and the burden of risk oversight to the right committee(s). ("We are all collectively responsible for risk," said a board member, while another added: "Audit committees tend to have a checklist approach to risk oversight, which is dangerous; not enough prioritization, not enough of a business angle.")


2. Consider the full breadth of material risks that can impact the company. ("We benchmark against a range of companies to make sure we think.")


3. Push for a deep understanding of the key risks. ("We spend a lot of time reviewing the numbers and understanding risk processes: where the key numbers come from, how they get into the reports.")


4. Secure the right expertise on the board. ("Transformation of our risk approach was driven by two board members with risk experience elsewhere.")


5. Nurture a healthy tension borne by diversity. ("The biggest change we made in risk management over the last few years is focusing on having the most diverse board possible.")


6. Engage the broad management team. ("The board needs to interact with management in an open manner, not just hear what has been rehearsed three times.")


7. Embed risk discussions in all board processes. ("Every initiative presented to the board concludes with a simple page with three to four bullets on the key risks.")


8. Avoid the "bureaucratic trap"—more substance, less process. ("When you ask an executive to go in depth on a specific risk and you get a blank stare, you know risk management has become too bureaucratic.")


9. Make risk management actionable, not just an exercise. ("Follow-up is critical—managers come back to the board and are asked 'tell me what you have done'—it is more than just a plan.")


10. Take ownership of improving risk management in the organization. ("To make risk management a success at our company the board had to get involved—we never gave up.")

This represents the new shift by boards to become more risk focused.  How does your company stack up against these best practices?  What other insights should be included on the list?  How do you engage senior management to embrace practices such as these?  If you are interested in joining the discussion, email us at NavigateSuccessfully@WheelhouseAdvisors.com.

New SEC Rules Are a Sign of the Times

According to a report today in the Wall Street Journal, the Securities and Exchange Commission is set to issue new disclosure rules for companies looking to reduce debt levels at the end of each quarter simply for reporting purposes. Inquiries into the use of repurchase agreements by financial services companies have revealed the widespread practice of reducing debt levels artificially.  Here is what the WSJ has discovered.

Federal regulators are poised to propose new disclosure rules targeting "window dressing," a practice undertaken by some large banks to temporarily lower their debt levels before reporting finances to the public.

The Securities and Exchange Commission is scheduled to take up the matter at a meeting Friday and is expected to issue proposals for public comment. The action follows a Wall Street Journal investigation into the practice, which isn't illegal but masks banks' true levels of borrowing and risk-taking.

A Journal analysis of financial data from 18 large banks known as primary dealers showed that as a group, they have consistently lowered debt at the end of each of the past six quarters, reducing it on average by 42% from quarterly peaks.

New rules like these are certainly a sign of the times and companies must be prepared for more to come.  To learn how Wheelhouse Advisors can help you prepare, visit www.WheelhouseAdvisors.com.

Risk Oversight at U.S. Companies Lags Behind

The American Institute of CPAs (AICPA) and the Chartered Institute of Management Accountants (CIMA) just released a study about the current state of enterprise risk oversight at major corporations across the globe.  The findings in the study that was conducted independently by North Carolina State University demonstrate the disparity in progress made by U.S. based companies versus the rest of the world.  The following are a few of the more telling results.

1. 84% of U.S. respondents assessed their risk oversight processes as ranging from very immature to only moderately mature. In contrast, 61% of the global respondents assessed their risk oversight as falling in those ranges. Only 1.5% of U.S. respondents and 8.2% of global respondents assessed their risk management oversights as ‘very mature/robust.’


2. There seems to be a noticeable difference in the extent that top risk exposures facing the organisation are formally discussed when the board of directors discusses the organisation’s strategic plan. Over 60% of global respondents indicated that the extent of discussion about top risk exposures facing the organisation was extensive to ‘a great deal.’ In contrast, only 39% of U.S. respondents rated the level of discussion to that extent.


3. 46% of global respondents describe their risk oversight process as systematic, robust, and repeatable in contrast to 11% of U.S. respondents who believe they have a complete enterprise-wide risk management process in place.


4. Most organisations have not formally designated an individual to serve as chief risk officer or equivalent, although global respondents indicated a higher occurrence (31%) in contrast to U.S. respondents (23%).


5. 50% of global respondents and just under one-third of U.S. respondents indicate that their boards of directors are increasing ‘extensively’ or ‘a great deal’ their focus on risk management activities and processes.

Based on these results, it is apparent that U.S. companies are lagging behind the rest of the world when it comes to risk oversight.  In order to successfully compete on the global stage, U.S. companies must begin to narrow the gap with increased investment in enterprise risk management programs.  Otherwise, a significant competitive advantage to manage risks in an increasingly complex world will be ceded to others.

Big Event in Basel

A major event for financial services companies across the globe is happening this weekend in Basel, Switzerland. Regulators from 27 countries are meeting there to finalize new rules that will impact how banks manage risk in the future.  Known as "Basel III", the new set of rules are a direct response to the financial crisis that began over two years ago.  The rules will take time to implement, but they are a significant shift from the Basel II Accord that allowed individual banks to determine their own capital levels based on their own internal rating system.  The Wall Street Journal reported the following today.

Convening in the Swiss city of Basel, the officials are hoping to cinch a deal this weekend. In one of the most far-reaching steps, the current proposal would require global banks to maintain basic levels of capital equal to at least 7% of their assets—much more than existing standards of roughly 4% for large U.S. banks.

The effort would transform banking, potentially forcing banks to take fewer risks, make less profit and face more government scrutiny. It comes nearly two years after the chaotic bankruptcy of Lehman Brothers convulsed the global economy and led to taxpayer-funded bailouts world-wide. U.S., European and Asian officials hope an accord will create new global standards designed to firm up the foundations of large international banks.

The hope of the Basel Committee on Banking Supervision is that the new rules will create a financial system that is more resilient and able to withstand future crises.  Only time will tell if this will be the case.

The CIA of Finance?

One of the new creations from the Dodd Frank Act of 2010 is the Office of Financial Research within the U.S. Department of Treasury. This new office's mission is to delve into the inner workings of the financial system to identify potential systemic risks. That means they have the power to secure any and all confidential information from financial services companies. As a result, many view the new office another CIA. Bloomberg Businessweek provided the following view in an article this week.

In a nod to its abilities to peer into the uncharted depths of the financial system, lobbyists are calling it the CIA of financial regulators. The analogy may not be far off. Housed within the Treasury, the office will have both data collection and analysis arms. The law says it can demand "all data necessary" from financial companies, including banks, hedge funds, private equity firms, and brokerages. That would include previously secret details such as who the counterparties are for credit default swaps and information on individual loans such as interest rate and maturity. If companies aren't forthcoming, the director of the office can issue subpoenas. Providing the staff support to the new Financial Stability Oversight Council—and holding a nonvoting seat on the council, which will monitor the banking system for risks—the research office can require companies to submit "periodic reports" to help it determine which firms to keep tabs on.

Proponents say the office's central mission is to help spot the next financial crisis as it is forming. "This gets to the essence of what really causes problems," says Clifford Rossi, a former chief risk officer at Citigroup (C) now with the University of Maryland's Center for Financial Policy. "No single agency was really looking holistically across the entire system, going 'holy smokes, we've got a bubble of monumental proportions here.' "

With new powers such as these, the U.S. government is increasing the level of regulatory risk for financial services companies and will certainly create a new sense of paranoia in the corporate world.

Now is a Great Time to Discuss Risks for 2011

As we head start to wrap-up the third quarter of 2010 and begin to finalize budgets and forecasts for 2011, it seems very appropriate to examine the big risks that are impacting companies and the overall economy.  A recent report by Ernst & Young on the top ten risks for 2010 is a great starting point for these types of discussion.  Below is their list for 2010 which will most likely change dramatically in 2011.

Regulation and compliance has resumed the Number 1 spot it last held in 2008, with concerns about this risk voiced across the majority of sectors. One of the most current worries among businesses is that the uncertainty surrounding regulation is stalling business decision-making and planning. (Rising from Number 2 in the 2009 report.)




Access to credit - Although this risk remains high, viewpoints regarding the availability of credit varied across sectors, with some interviewees indicating that the threat has receded. However, rising levels of government debt may have a strong impact on the cost of credit in the future. (Falling from Number 1 in the 2009 report.)




Slow recovery or double-dip recession - Although the financial crisis has abated, a fiscal crisis has emerged in its place. There is no guarantee that global growth will be sustained if stimulus packages are withdrawn. (No change from the 2009 report.)




Managing talent - Companies face a number of threats linked to the management of human capital. The global war for talent continues to pose a challenge in some sectors, the approaching retirement of the baby boomers looms over others and, the debate over compensation structures is ongoing, especially in the financial sector. (Rising from Number 7 in the 2009 report.)




Emerging markets - With emerging economies likely to dominate global growth, succeeding in these markets has become a strategic imperative. (Rising from Number 12 in the 2009 report.)




Cost cutting - Although this risk remains at Number 6, specific concerns among sectors have shifted from last year. Commodity price inflation and pressure from low cost competitors are now rising challenges. However, pressures to control costs to preserve financial viability have receded. (No change from the 2009 report.)




Non-traditional entrants - This risk fell two places from 2009, as higher costs of capital and declining demand sapped the strength of some emerging competitors. Further, incumbent firms in transitioning sectors, having had some years to adjust to new entrants, have been able to shore up their positions. (Falling from Number 5 in the 2009 report.)




Radical greening - In the current economic climate, environmental issues are not at the top of the agenda, and this challenge has slipped down the rankings this year. However, companies continue to strive to stay ahead of shifting consumer preferences and government regulation. (Falling from Number 4 in the 2009 report.)




Social acceptance and corporate social responsibility (CSR) have become increasingly important over the last decade and it is not a surprise to find this risk entering the top 10 this year. In the current business climate, where there are continuing reputational threats and a rising political backlash, firms will need to tread carefully to maintain (or rebuild) the trust of the public. (New this year.)




Executing alliances and transactions - Over the past year there has been a noticeable decline in merger and acquisition activity as finance has become costly. However, rescue mergers in the wake of the financial crisis and regulatory changes that may force new transactions remained topical. (Falling from Number 8 in the 2009 report.)

How do you see the list evolving next year?  Those who predict the changes and manage the risks successfully will have a significant competitive advantage resulting in major gains.  Those who do not have a forward-looking view of how these changing risks will impact their business will suffer as a result.  If you are interested in having a facilitated risk discussion, email us at NavigateSuccessfully@WheelhouseAdvisors.com.

New SEC Rules Serve as a Warning to Boards

Large U.S. corporations were recently placed on notice by the Securities & Exchange Commission ("SEC") that shareholders will have a larger voice in determining board members going forward.  Just last week, the SEC adopted new proxy access rules that could have a significant impact on companies who anger their shareholders by not managing their risks well.  Crain's New York had a very interesting report on the potential impact of the changes on companies like Goldman Sachs.  Here's their view.

Goldman Sachs is target No. 1 for activist investors looking to shake up corporate boards now that the Securities and Exchange Commission has made it easier for shareholders to nominate directors.  Corporate governance activists are looking to replace Goldman directors at the firm's annual meeting next spring unless the board strips Chief Executive Lloyd Blankfein of his position as chairman.

The SEC determined that investors can nominate their own directors if they own as little as 3% of a company's stock and can combine their holdings with other shareholders to reach the threshold. It's a sea change for board elections, where candidates in most cases are selected by management only. While investors are limited to nominating 25% of directors in any year, the power they've been granted by the government is considered so worrisome that the U.S. Chamber of Commerce is threatening to sue.

Boards and senior management need to ensure that they are working well together to anticipate risk events like the one Goldman Sachs experienced to protect their shareholders and their positions.  The best way to achieve this goal is to have a strong enterprise risk management program in place.  To learn more about how Wheelhouse Advisors can help your company implement a strong ERM program, visit www.WheelhouseAdvisors.com.