20090526_2

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Shandong Foreign Trade Administration Bureau

Workshop about Enterprise Risk Management

(ERM)

Jinan, May 26 th – 2009

by

Wolf-Bernhard KERSTEN

Professor of Economics

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Agenda: Chapters …

1. Introduction

2. Global Financial Crises, World – Wide Recession and the Impacts on

China

3. The ERM: Concept + Theory

4. The ERM: Implementation Procedures

5. The ERM: Implementation in China

6. Q + A

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Chapter 1: Introduction

1.1 About the lecturer1.2 Target of this work shop

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1.1. About the lecturer: summary CV (1)

• Education

< Banker

< graduated School of Economics, German Nr. 1 University

< Associate Professor

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• Business career: global nr. 1 Credit Insurer

< Sales Area Manager

< Director Sales Regional

< Director Sales Domestic Bank-Assurance

< Head of Bank-Assurance

< MD of Group Collection Company

< Member of the Executive Management (15 years)

< CSO Asia – Pacific (8 years)

< CEO, Chairman, President in 10 Asian countries

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• Academic Career: Professor at various Universities

< since 2002: Hamburg, School of Economics, MBA

< Tianjin, Nankai University, School of Economics

< Beijing TBU, School of Finance + Trade

< Shanghai, East China UST, MBA

< Shanghai, IBFI, MBA

< Shanghai, CEIBS, MBA (EU-China Program)

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• Advisor / Consultant: in total 12, for … e.g.

< leading Credit Insurers in China< Re – Insurers

< Banks

< Central -, Provincial - + Municipality Governments

< Economic Development Zones

< Chinese - + Western Enterprises< COO Olympics, Beijing 2008, German Hockey Association

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1.1. About the lecturer: summary CV (5)1.1. About the lecturer: summary CV (5)

• Majors:

< Strategic Management< Marketing + Sales

< Finance + Funding

< ERM

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• Assets, Strengths

< International (over 100 countries globally)

< bi - lingual (German-English)

< plus 3 more languages

< in China living since 2001

< wide + deep “guanxi”

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1.2. Target of this Work Shop

< to support Shandong Government

< to help to implement ERM into local enterprises

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Chapter 2: The Global Financial Crises, the

World-wide Recession and the Impacts on China

2.1 Summary Report to the Central Government: highlights

2.2 Actions, China should do now

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2.1. Summary Report: highlights (1)

< Start of the Financial Crises

< Historical, political, social + economical history

< Global Interdependency of Risks – Spread

< Impact on world-wide Recession

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2.1. Summary Report: highlights (2)

< 3 rd generation of financing products

(CDS, STS … gambling character) < Normative failures

(Greed, Rating Agencies, Supervisory Authorities …)

< Wrong capitalism theory approach

< 98 % of all bankers + Governmental Officials: no clue

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2.1. Summary report: highlights (3)

< Recession started end of 2007, but …

< Prices increased (commodities, interests … ) < Credits became delinquent (private, commercial)

< ABS/MBS – CP became toxic

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< Inter - Banking cash system collapsed

< First Banks collapsed (UK, US)

< Cash deficit in the production market

< Mistrust against Banks + Government

< Insolvency ratio increased

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< Macro – economical dependencies

< Im – and Export< Saving and consumption

< Bubble global economy

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< Banks and Insurers collapsed (UK, US)

< Mio of employees lost jobs

< GDP: Germany: minus 5 %, Japan: minus 4 %

< Tiger States: all minus GDP

< biggest recession since 1929

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< Governments had to react (G – 20)

< now all major banks and insurers in the West belong to

the Government (similar to China)

< the consequences will last for the next years< the printing of fresh money will lead to a hyper – inflation

< the US household shows a deficit spending which will impact

the US policy for the next 20 - 30 years

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< Consequences for China:

< Economic down-turn

< Export ratio down since 6 months with minus 20 %

< in 2009: 15.000 companies closed in South of China

< 70.000 toy factories closed

< 40 mio workers lost jobs

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< Consequences for China:< GDP 2009: increase with + 5 % ? (IFC, Worldbank)

< GDP 2010: increase with + 6 % ?

< break - even GDP: + 8 %, otherwise …

< but: financial stability, huge currency reserves

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< Consequences for China:

< Dependency on world trade huge

< Dependency on USD huge (depreciation risk)< China acts de facto as “Bank for America”

< Unemployment rate will increase (social instability)

< University graduates no chance for jobs

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2.2. Actions China should do now:

in total 28 (1)

< Macro – economical and fiscal

< Social welfare (health, pension)< Stimulation package too late + too small ?

< Central regulation + planning possible ?

< Corruption problem unsolved

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2.2. Actions China should do now:

in total 28 (2)

< Domestic demand increase possible ?

< Infrastructure projects take too long ?< Environment problems will increase tax burden

< Education programs more professional + faster

< Micro – lending systems underdeveloped

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Chapter 3: The ERM – Concept + Theory

3.1 The Basics of ERM3.2 The Advantages

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3.1. The Basics of ERM (1)

< ERM regards the company as a human being

< ERM follows the thinking of the TCM

< body, soul, brain, heart – all is interdependent

< it is a mathematical matrix approach

< it helps to steer the complex business reality

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< it forces all levels in a company to permanently reconsider,

that all actions will have an impact on many other levels

and functions (chain reaction)

< it is an integrated, interdependent approach

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< however it is not easy to implement

< it takes about 3 years in reality

< it needs much training work

< but: it is the best Management Strategy to date

< it has been approved by the FORTUNE 500

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< the key elements are:

< we regard all functions from the risk perspective< whatever we do, it is risky

< but risks are now a chance and not a threat

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< it defines all risks in the work flow chain

< it measures all risks in quantitative figures

< risks which cannot measured must be deleted

< only business which brings profit will be conducted

< it is based on a clear Strategic Management Approach

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< it permanently allocates the resources of the company

< “are we doing the right things – and if so:are we doing them right?”

< first step is a qualitative SWOT analysis

< the two key elements are: how do we handle mistakes –

and what is our USP ?

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< it needs clear objectives which are measurable

< it needs a controlling tool

< it needs handbooks, guidelines, job descriptions etc

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< what is a risk?

< it is the uncertainty of outcomes and the likelihood

of an impact on the objectives of a company

< it asks for the “risk price”

< it asks for avoiding, mitigating or transferring of risks

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3.2. The Advantages of ERM (1)

< ERM driven enterprises are 25 % more intelligent than others

< the knowledge level of each staff increases permanently< 80 % of all functions now become measurable

< decisions can be based much more on facts and not on feelings

< the company acts “professional”

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3.2. The Advantages of ERM (2)

< the staff is more happy (happiness leads to more success)< the efficiency ratio increases y-o-y with 50 to 70 %

< the intangible assets can be bundled (EDP system)

< the profit and the market share increase (rating)

< the insolvency risk for the own company decreases

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Chapter 4: The Implementation of ERM

4.1 The Strategic Management Approach

4.2 The Treatment of Risks – and Risks Components4.3 The 12 Major Types of Risks in detail and its interdependencies

4.4 The Experience in the West about ERM

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4.1 The Strategic Management Approach

(1)

< starts with a vision statement: where do we want to go ?

< defines the long term target of a company

< e.g.: “we want to become nr. 1 in our niche market”

< follows a cycle approach: from top to down and back

< every department defines its own vision, following the group vision

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4.1. The Strategic Management Approach

(2)

< followed by the “mission statement”:

how do we want to reach our long term goal?< defines the allocation of resources within the group

< resources: human capital, finance capital, fixed assets,

intangible assets

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(3)

< every department now decides about their respective “objectives”

< the Top Management checks and revises

< objectives are always measurable:

“department x will increase its market share on market A with 13 %”

< or: “production costs of product III will be decreased with 20 %”.

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(4)

< every employee gets its own objectives

< this needs a clear job description

< plus: guidelines, handbooks, communication and reporting rules,

manuals etc

< plus: training and education manuals

< note: training is mandatory for all staffs (incl. Top Management)

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(5)

< vision, mission and all dep. objectives will be made transparent

< the Controlling department monitors and reports m – b – m< the schedule for the planning process starts in August

for the next year (roll-over planning)

< the key figure is the EVA

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4.2. The Treatment of Risks and Risk –

Components (1)

< whatever you do, it has a risk< even if you don t do anything, it inherits a risk

< risks are unavoidable in business life

< companies which are risk-avers live longer

< per year, companies face about 1 million risks

(risk dilemma)

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4.2. The Treatment of Risks and Risk –

Components (2)

< intelligent enterprises implement a CRO

< in fact it is a part of the Controlling Department< there are some institutes and universities who offer risk management

courses including BA and MA degrees

< the CRO has one target: no surprise, whatever happens, he has a planB or C on his desk

< seminars about risk treatment are the most challenging at Universities

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4.2. The Treatment of Risks – and Risk

Components (3)

• ERM knows 7 Risk Components

< exposure< volatility

< probability

< severity

< horizon

< correlations

< capital

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4.2. The treatment of Risks – and Risk

Components (4)

< Risk exposure = how much can we lose as a maximum?< Risk volatility = is the variability of potential outcomes of risks

< Risk probability = how likely a risk can occur?

< Risk severity = how high is the real damage if the risk occurs?

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Components (5)

< Risk horizon = when and how long can the risk happen?

< Risk correlations = how are different risks correlated positive

or negative to others?

< Risk capital = how high should we accumulate our capital to cover the

risk components, or: can we buy an insurance or

re-insurance treaty, or: should we set up a captive company?

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Components (6)

< Each type or Risk (see 4.3.) now will be matched with these 7 RiskComponents

< The result is a matrix with many mathematical, arithmetical andstatistical equations

< The results will be ranked (peer comparison) and matched with theGroup – EVA

< The responsible leader has to explain the reasons

< The consequences will be offered as alternatives (option plans)

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4.3. The 12 major Types of Risks (ToR) in

detail and the interdependencies (1)

• ToR are classified into

< internal, and

< external

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< internal ToR are:Hazard and operational risks

< external ToR are:

Strategic and financial risks

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• hazard risks include:

< Public access< Misbehaviour of employees

< Products and services

• these risks can lead to massive image (reputation) losses

• image losses are the most dangerous risks,

• they are hidden, uncontrollable and unpredictable

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• Operational risks include:

< Recruitment (HR risks)< Supply chain

< Business operation

< IT

< Internal Regulations

< Cultural< Top Management

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• Financial Risks include:

< Interests and foreign currency exchange risks< Credit risks

< Inflation risks

< Purchasing Power

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•the variation of risks:< Time to time

< Country to country

< Sector to sector

< Quality

< Quantity

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< the biggest risk is the Market Risk

It is related to the P – M – S – Strategy of a company< the BMT is the Marketing Management

< rule: the more international, the more excellent the P-M-S Strategy

< market risks cannot be avoided, just minimized

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• the second biggest risk is the efficiency achievement risk

It is related to:< Quantities (output)

< Qualities (search for excellence)

< Work flow structure

< Time (on-time delivery)

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< its key figure is the EVA

< are we efficient and effective?

< what jobs, products etc must be deleted or re-designed?

< the inefficiency achievement risk is dangerous because it is a

hidden risk

< many Chinese companies say: we work hard, we try our best …

Instead of: we will be efficient.

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• the third biggest risk is the liquidity risk

< it is related to insufficient cash flow, working capital, bank credit

facilities, supplier credit

< it may lead to a fast death of the company

(liquidity is like drinking, profit is like eating)

< a good manager cares first about the cash flow< at my MBA courses in finance, I focus on cash flow management

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• Nr. 4 is the credit and commercial delinquency risk

< it is related to the inability or unwillingness of the buyer to fulfill his

contractual obligations< it is the first ToR which can be insured, the first 3 ToR cannot be

insured

< the respective insurer is the Credit Insurance

< A credit insurer is a mixture of a huge bank and a huge insurer

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< case studies prove what really happens if a buyer goes bust

< a credit insurance offers 7 big advantages

< the indemnification of a loss is just one of them

< 80 % of the FORTUNE 500 use credit insurance

< some sectors in the West use 100 % credit insurance

< 30 % of insolvencies are caused by domino effects

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< in the West, if a CEO or CFO or MD loses big money due to a default of a

buyer and he has not signed a credit insurance, he will be fired< big insolvencies come overnight (sudden death) and no supplier has any

chance to react

< the biggest advantage of a credit insurance is that it automatically coversor eases the first 3 biggest ToR

< This is the reason why it is so popular in the West

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• the 5. th biggest is the IT (MIS) – Risk< a break-down of the IT-system and no back – up function can kill the

whole business

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• the 6 th biggest risk is the legal risk

< it is related to (insufficient) laws, regulations, court actions, IPRproblems etc in the various countries

< it is closely related to political risks

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• the political risk is the 7 th biggest risk

< it is related to the internal and external stability (country ceiling)

< all Rating Agencies, Banks and Credit Insurer offer Country Ratings

< however: all ratings are subjective and many Rating Agencies in China

do not match quality standards.

< Moreover: the big 3 international Rating Agencies (US based) were

heavily negative involved in the current financial crises

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• Nr. 8 is fraud, embezzlement and corruption

< this applies to the West, in China this risk is nr. 2

< in the West losses caused by these risk are higher than fire damages< In the West, this risk can be insured, but not in China

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• nr. 9 is the capital risk

< it is related to the whole capital + funding of a company

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•

nr. 10 is the environment risk< this applies to the West

< in China this risk nr. 3

< it is related to the contamination of air, water, ground

< in China, water will become nr. 1 risk soon

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• Nr. 11 is the elemental force risk

< it is related to all natural disasters

< in China this risk is much higher (earthquake, typhoon, draught)

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• Nr. 12 is the epidemic disease risk

< to day it is a global risk (SARS, bird flu, swine flu)< it can damage a whole economy

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4.4. The Experiences in the West with ERM

< companies using ERM gain in average a 25 % higher profit

< their shareholder value increased 28 % higher than others

< in Germany, due to a special Risk Transparency law, all listed companies

have to follow the ERM approach

< in the US, SoX Act 404 stipulates similar tools, but …

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Chapter 5:How to proceed in reality in

China when using ERM?

Some practical advises

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5. How to proceed in reality in China when

using ERM? (1)

< in 2007, the Central Government has released a regulation that all

companies – step by step – have to follow ERM

< first the banks, then the insurers, then the SOE

< however: the implementation ratio has reached about only 11 %

< a better and faster way, is to offer seminars, work shops for the local

enterprises in the different provinces< every good idea needs a promoter

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using ERM? (2)

• in reality, ERM starts with a SWOT, based on many check lists

there are 4 different concepts which have been approved:

< The short and concentrated assessment< The concentration on one ToR

< The training of the staffs

< a combination of these

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using ERM? (3)

< another concept is – lead by a foreign expert – to implement a risk working

group on city - or provincial level< this group can work out guidelines

< the foreign expert can train the group members

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using ERM? (4)

< also, a good solution is to set up special sector risk working groups< they are lead by the foreign expert and concentrate only on one sector and

its risks (may be: chemistry or machinery etc)

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Chapter 6: Q + A

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Xiexie

Contact me:

Contact: [email protected]

mailto:[email protected]



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Abbreviations used (1)

ABS = Asset Backed Securities

BMT = Basic Management Tools

BTBU = Beijing Technology + Business University

CDS = Credit Default Swaps

CEIBS = China European International Business School

CEO = Chief Executive Officer

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COO = Chief Operating Officer

CP = Commercial Paper

CRO = Chief Risk OfficerCV = Curriculum Vitae

ECUST = East China University of Science + Technology

EDP = Expert Data Pool

e.g. = example given

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ERM = Enterprise Risk Management

EU = European UnionEVA = Economic Value Added

GDP = Gross Domestic Product

G-20 = Top 20 country leader meeting

IFC = International Finance Corporation

IT = Information Technology

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M+A = Mergers + Acquisition

MBA = Master of Business AdministrationMBS = Mortgage Backed Securities

MD = Managing Director

Mio = Million (s)

m-p-m = month per month

PMS = Product-Market-Sales

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Q+A = Questions + Answers

SIBFI = Shanghai International Banking + Finance Institute

SoX 404 = Sarbanes – Oxley Act Nr. 404

STS = Short Term Selling

SWOT = Strengths, Weaknesses, Opportunities, Threats

TCM = Traditional Chinese Medicine

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ToR = Types of Risks

UK = United KingdomUS = United States

USD = US Dollar currency

USP = Unique Selling Proposition

y-o-y = year on year

20090526_2

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