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.