Shandong Foreign Trade Administration Bureau Workshop about Enterprise Risk Management ERM Jinan, Ma

1
Shandong Foreign Trade Administration
BureauWorkshop about Enterprise Risk Management
(ERM)Jinan, May 26 th 2009 byWolf-Bernhard
KERSTENProfessor of Economics
2
Agenda Chapters

• Introduction
• Global Financial Crises, World Wide Recession
  and the Impacts on China
• The ERM Concept Theory
• The ERM Implementation Procedures
• The ERM Implementation in China
• Q A

3
Chapter 1 Introduction

• 1.1 About the lecturer
• 1.2 Target of this work shop

4
1.1. About the lecturer summary CV (1)

• Education
• lt Banker
• lt graduated School of Economics, German Nr.
  1 University
• lt Associate Professor

5
1.1. About the lecturer summary CV (2)

• Business career global nr. 1 Credit Insurer
• lt Sales Area Manager
• lt Director Sales Regional
• lt Director Sales Domestic Bank-Assurance
• lt Head of Bank-Assurance
• lt MD of Group Collection Company
• lt Member of the Executive Management (15
  years)
• lt CSO Asia Pacific (8 years)
• lt CEO, Chairman, President in 10 Asian
  countries

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1.1. About the lecturer summary CV (3)

• Academic Career Professor at various
  Universities
• lt since 2002 Hamburg, School of Economics,
  MBA
• lt Tianjin, Nankai University, School of
  Economics
• lt Beijing TBU, School of Finance Trade
• lt Shanghai, East China UST, MBA
• lt Shanghai, IBFI, MBA
• lt Shanghai, CEIBS, MBA (EU-China Program)

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1.1. About the lecturer summary CV (4)

• Advisor / Consultant in total 12, for e.g.
• lt leading Credit Insurers in China
• lt Re Insurers
• lt Banks
• lt Central -, Provincial - Municipality
  Governments
• lt Economic Development Zones
• lt Chinese - Western Enterprises
• lt COO Olympics, Beijing 2008, German Hockey
  Association

8
1.1. About the lecturer summary CV (5)
1.1. About the lecturer summary CV (5)

• Majors
• lt Strategic Management
• lt Marketing Sales
• lt Finance Funding
• lt ERM

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1.1. About the lecturer summary CV (6)

• Assets, Strengths
• lt International (over 100 countries
  globally)
• lt bi - lingual (German-English)
• lt plus 3 more languages
• lt in China living since 2001
• lt wide deep guanxi

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1.2. Target of this Work Shop

• lt to support Shandong Government
• lt 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)

• lt Start of the Financial Crises
• lt Historical, political, social economical
  history
• lt Global Interdependency of Risks Spread
• lt Impact on world-wide Recession

13
2.1. Summary Report highlights (2)

• lt 3 rd generation of financing products
• (CDS, STS gambling character)
• lt Normative failures
• (Greed, Rating Agencies, Supervisory Authorities
  )
• lt Wrong capitalism theory approach
• lt 98 of all bankers Governmental Officials
  no clue

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2.1. Summary report highlights (3)

• lt Recession started end of 2007, but
• lt Prices increased (commodities, interests )
• lt Credits became delinquent (private, commercial)
• lt ABS/MBS CP became toxic

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2.1. Summary report highlights (4)

• lt Inter - Banking cash system collapsed
• lt First Banks collapsed (UK, US)
• lt Cash deficit in the production market
• lt Mistrust against Banks Government
• lt Insolvency ratio increased

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2.1. Summary report highlights (5)

• lt Macro economical dependencies
• lt Im and Export
• lt Saving and consumption
• lt Bubble global economy

17
2.1. Summary report highlights (6)

• lt Banks and Insurers collapsed (UK, US)
• lt Mio of employees lost jobs
• lt GDP Germany minus 5 , Japan minus 4
• lt Tiger States all minus GDP
• lt biggest recession since 1929

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2.1. Summary report highlights (7)

• lt Governments had to react (G 20)
• lt now all major banks and insurers in the West
  belong to
• the Government (similar to China)
• lt the consequences will last for the next years
• lt the printing of fresh money will lead to a
  hyper inflation
• lt the US household shows a deficit spending which
  will impact
• the US policy for the next 20 - 30
  years

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2.1. Summary report highlights (8)

• lt Consequences for China
• lt Economic down-turn
• lt Export ratio down since 6 months with minus 20
  
• lt in 2009 15.000 companies closed in South of
  China
• lt 70.000 toy factories closed
• lt 40 mio workers lost jobs

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2.1. Summary report highlights (9)

• lt Consequences for China
• lt GDP 2009 increase with 5 ? (IFC,
  Worldbank)
• lt GDP 2010 increase with 6 ?
• lt break - even GDP 8 , otherwise
• lt but financial stability, huge currency reserves

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2.1. Summary report highlights (10)

• lt Consequences for China
• lt Dependency on world trade huge
• lt Dependency on USD huge (depreciation risk)
• lt China acts de facto as Bank for America
• lt Unemployment rate will increase (social
  instability)
• lt University graduates no chance for jobs

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2.2. Actions China should do now in total 28 (1)

• lt Macro economical and fiscal
• lt Social welfare (health, pension)
• lt Stimulation package too late too small ?
• lt Central regulation planning possible ?
• lt Corruption problem unsolved

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2.2. Actions China should do now in total 28 (2)

• lt Domestic demand increase possible ?
• lt Infrastructure projects take too long ?
• lt Environment problems will increase tax burden
• lt Education programs more professional faster
• lt Micro lending systems underdeveloped

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Chapter 3 The ERM Concept Theory

• 3.1 The Basics of ERM
• 3.2 The Advantages

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3.1. The Basics of ERM (1)

• lt ERM regards the company as a human being
• lt ERM follows the thinking of the TCM
• lt body, soul, brain, heart all is
  interdependent
• lt it is a mathematical matrix approach
• lt it helps to steer the complex business reality

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3.1. The Basics of ERM (2)

• lt 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)
• lt it is an integrated, interdependent approach

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3.1. The Basics of ERM (3)

• lt however it is not easy to implement
• lt it takes about 3 years in reality
• lt it needs much training work
• lt but it is the best Management Strategy to date
• lt it has been approved by the FORTUNE 500

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3.1. The Basics of ERM (4)

• lt the key elements are
• lt we regard all functions from the risk
  perspective
• lt whatever we do, it is risky
• lt but risks are now a chance and not a threat

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3.1. The Basics of ERM (5)

• lt it defines all risks in the work flow chain
• lt it measures all risks in quantitative figures
• lt risks which cannot measured must be deleted
• lt only business which brings profit will be
  conducted
• lt it is based on a clear Strategic Management
  Approach

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3.1. The Basics of ERM (6)

• lt it permanently allocates the resources of the
  company
• lt are we doing the right things and if so
• are we doing them right?
• lt first step is a qualitative SWOT analysis
• lt the two key elements are how do we handle
  mistakes
• and what is our USP ?

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3.1. The Basics of ERM (7)

• lt it needs clear objectives which are measurable
• lt it needs a controlling tool
• lt it needs handbooks, guidelines, job
  descriptions etc

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3.1. The Basics of ERM (8)

• lt what is a risk?
• lt it is the uncertainty of outcomes and the
  likelihood
• of an impact on the objectives of a company
• lt it asks for the risk price
• lt it asks for avoiding, mitigating or
  transferring of risks

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3.2. The Advantages of ERM (1)

• lt ERM driven enterprises are 25 more
  intelligent than others
• lt the knowledge level of each staff increases
  permanently
• lt 80 of all functions now become measurable
• lt decisions can be based much more on facts and
  not on feelings
• lt the company acts professional

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3.2. The Advantages of ERM (2)

• lt the staff is more happy (happiness leads to
  more success)
• lt the efficiency ratio increases y-o-y with 50 to
  70
• lt the intangible assets can be bundled (EDP
  system)
• lt the profit and the market share increase
  (rating)
• lt 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
  Components
• 4.3 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)

• lt starts with a vision statement where do we
  want to go ?
• lt defines the long term target of a company
• lt e.g. we want to become nr. 1 in our niche
  market
• lt follows a cycle approach from top to down and
  back
• lt every department defines its own vision,
  following the group vision

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4.1. The Strategic Management Approach (2)

• lt followed by the mission statement
• how do we want to reach our long term goal?
• lt defines the allocation of resources within the
  group
• lt resources human capital, finance capital,
  fixed assets,
• intangible assets

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4.1. The Strategic Management Approach (3)

• lt every department now decides about their
  respective objectives
• lt the Top Management checks and revises
• lt objectives are always measurable
• department x will increase its market share on
  market A with 13
• lt or production costs of product III will be
  decreased with 20 .

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4.1. The Strategic Management Approach (4)

• lt every employee gets its own objectives
• lt this needs a clear job description
• lt plus guidelines, handbooks, communication and
  reporting rules, manuals etc
• lt plus training and education manuals
• lt note training is mandatory for all staffs
  (incl. Top Management)

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4.1. The Strategic Management Approach (5)

• lt vision, mission and all dep. objectives will be
  made transparent
• lt the Controlling department monitors and reports
  mbm
• lt the schedule for the planning process starts in
  August
• for the next year (roll-over planning)
• lt the key figure is the EVA

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4.2. The Treatment of Risks and Risk Components
(1)

• lt whatever you do, it has a risk
• lt even if you dont do anything, it inherits a
  risk
• lt risks are unavoidable in business life
• lt companies which are risk-avers live longer
• lt per year, companies face about 1 million risks
• (risk dilemma)

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4.2. The Treatment of Risks and Risk Components
(2)

• lt intelligent enterprises implement a CRO
• lt in fact it is a part of the Controlling
  Department
• lt there are some institutes and universities who
  offer risk management courses including BA and MA
  degrees
• lt the CRO has one target no surprise, whatever
  happens, he has a plan B or C on his desk
• lt 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
• lt exposure
• lt volatility
• lt probability
• lt severity
• lt horizon
• lt correlations
• lt capital

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4.2. The treatment of Risks and Risk Components
(4)

• lt Risk exposure how much can we lose as a
  maximum?
• lt Risk volatility is the variability of
  potential outcomes of risks
• lt Risk probability how likely a risk can occur?
• lt Risk severity how high is the real damage if
  the risk occurs?

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4.2. The Treatment of Risks and Risk Components
(5)

• lt Risk horizon when and how long can the risk
  happen?
• lt Risk correlations how are different risks
  correlated positive
• or
  negative to others?
• lt 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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4.2. The Treatment of Risks and Risk Components
(6)

• lt Each type or Risk (see 4.3.) now will be
  matched with these 7 Risk Components
• lt The result is a matrix with many mathematical,
  arithmetical and statistical equations
• lt The results will be ranked (peer comparison)
  and matched with the Group EVA
• lt The responsible leader has to explain the
  reasons
• lt 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
• lt internal, and
• lt external

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4.3. The 12 major Types of Risks (ToR) in detail
and the interdependencies (2)

• lt internal ToR are
• Hazard and operational risks
• lt external ToR are
• Strategic and financial risks

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4.3. The 12 major Types of Risks (ToR) in detail
and the interdependencies (3)

• hazard risks include
• lt Public access
• lt Misbehaviour of employees
• lt 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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4.3. The 12 major Types of Risks (ToR) in detail
and the interdependencies (4)

• Operational risks include
• lt Recruitment (HR risks)
• lt Supply chain
• lt Business operation
• lt IT
• lt Internal Regulations
• lt Cultural
• lt Top Management

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4.3. The 12 major Types of Risks (ToR) in detail
and the interdependencies (5)

• Strategic Risks include
• lt Competition per product and market
• lt Customer demand changes
• lt Regulatory and political changes
• lt MA reactions (80 of all MA go bust)

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4.3. The 12 major Types of Risks (ToR) in detail
and the interdependencies (6)

• Financial Risks include
• lt Interests and foreign currency exchange
  risks
• lt Credit risks
• lt Inflation risks
• lt Purchasing Power

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4.3. The 12 major Types of Risks (ToR) in detail
and the interdependencies (7)

• the variation of risks
• lt Time to time
• lt Country to country
• lt Sector to sector
• lt Quality
• lt Quantity

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4.3. The 12 major Types of Risks (ToR) in detail
and the interdependencies (8)

• lt the biggest risk is the Market Risk
• It is related to the P M S Strategy of a
  company
• lt the BMT is the Marketing Management
• lt rule the more international, the more
  excellent the P-M-S Strategy
• lt market risks cannot be avoided, just minimized

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4.3. The 12 major Types of Risks (ToR) in detail
and the interdependencies (9)

•  the second biggest risk is the efficiency
  achievement risk
•   It is related to
• lt Quantities
  (output)
•   lt Qualities
  (search for excellence)
•   lt Work flow
  structure
•   lt Time (on-time
  delivery)

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4.3. The 12 major Types of Risks (ToR) in detail
and the interdependencies (10)

• lt its key figure is the EVA
• lt are we efficient and effective?
• lt what jobs, products etc  must be deleted or
  re-designed?
• lt the inefficiency achievement risk is dangerous
  because it is a
• hidden risk
• lt many Chinese companies say we work hard, we
  try our best
•   Instead of we will be efficient.

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4.3. The 12 major Types of Risks (ToR) in detail
and the interdependencies (11)

• the third biggest risk is the liquidity risk
• lt it is related to insufficient cash flow,
  working capital, bank credit
• facilities, supplier credit
• lt it may lead to a fast death of the
  company
•   (liquidity is like drinking, profit is
  like eating)
• lt a good manager cares first about the cash
  flow
• lt at my MBA courses in finance, I focus on
  cash flow management

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4.3. The 12 major Types of Risks (ToR) in detail
and the interdependencies (12)

• Nr. 4 is the credit and commercial delinquency
  risk
• lt it is related to the inability or
  unwillingness of the buyer to fulfill his
• contractual obligations
• lt it is the first ToR which can be insured,
  the first 3 ToR cannot be
• insured
• lt the respective insurer is the Credit
  Insurance
• lt A credit insurer is a mixture of a huge
  bank and a huge insurer

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4.3. The 12 major Types of Risks (ToR) in detail
and the interdependencies (13)

• lt case studies prove what really happens if a
  buyer goes bust
• lt a credit insurance offers 7 big advantages
• lt the indemnification of a loss is just one of
  them
• lt 80 of the FORTUNE 500 use credit insurance
• lt some sectors in the West use 100 credit
  insurance
• lt 30 of insolvencies are caused by domino
  effects

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4.3. The 12 major Types of Risks (ToR) in detail
and the interdependencies (14)

• lt  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
• lt  big insolvencies come overnight (sudden
  death) and no supplier has any chance to react
• lt  the biggest advantage of a credit insurance
  is that it automatically covers or eases the
  first 3 biggest ToR
• lt  This is the reason why it is so popular in
  the West

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4.3. The 12 major Types of Risks (ToR) in detail
and the interdependencies (15)

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

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4.3. The 12 major Types of Risks (ToR) in detail
and the interdependencies (16)

• the 6 th biggest risk is the legal risk
• lt  it is related to (insufficient) laws,
  regulations, court actions, IPR
• problems etc in the various countries
• lt   it is closely related to political risks

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4.3. The 12 major Types of Risks (ToR) in detail
and the interdependencies (17)

• the political risk is the 7 th biggest risk
• lt  it is related to the internal and
  external stability (country ceiling)
• lt  all Rating Agencies, Banks and Credit
  Insurer offer Country Ratings
• lt  however all ratings are subjective and
  many Rating Agencies in China
• do not match quality standards.
• lt  Moreover the big 3 international
  Rating Agencies (US based) were
• heavily negative involved in the
  current financial crises

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4.3. The 12 major Types of Risks (ToR) in detail
and the interdependencies (18)

• Nr. 8 is fraud, embezzlement and corruption
• lt  this applies to the West, in China
    this risk is nr. 2
• lt  in the West losses caused by these risk
  are higher than fire damages
• lt  In the West, this risk can be insured,
  but not in China

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4.3. The 12 major Types of Risks (ToR) in detail
and the interdependencies (19)

• nr. 9 is the capital risk
• lt  it is related to the whole capital
  funding of a company

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4.3. The 12 major Types of Risks (ToR) in detail
and the interdependencies (20)

• nr. 10 is the environment risk
• lt  this applies to the West
• lt  in China this risk  nr. 3
• lt  it is related to the contamination of
  air, water, ground
• lt  in China, water will become nr. 1 risk
  soon

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4.3. The 12 major Types of Risks (ToR) in detail
and the interdependencies (21)

•  Nr. 11 is the elemental force risk
• lt  it is related to all natural disasters
• lt  in China this risk is much higher
  (earthquake, typhoon, draught)

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4.3. The 12 major Types of Risks (ToR) in detail
and the interdependencies (22)

• Nr. 12 is the epidemic disease risk
• lt  to day it is a global risk (SARS, bird
  flu, swine flu)
• lt  it can damage a whole economy

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4.4. The Experiences in the West with ERM

• lt companies using ERM gain in average a 25
  higher profit
• lt their shareholder value increased 28 higher
  than others
• lt in Germany, due to a special Risk Transparency
  law, all listed companies
• have to follow the ERM approach
• lt in the US, SoX Act 404 stipulates similar
  tools, but

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Chapter 5How 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)

• lt in 2007, the Central Government has released a
  regulation that all
• companies step by step have to follow ERM
• lt first the banks, then the insurers, then the
  SOE
• lt however the implementation ratio has reached
  about only 11
• lt a better and faster way, is to offer seminars,
  work shops for the local
• enterprises in the different provinces
• lt every good idea needs a promoter

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5. How to proceed in reality in China when using
ERM? (2)

• in reality, ERM starts with a SWOT, based on many
  check lists
• there are 4 different concepts which have
  been approved
•   lt  The short and concentrated
  assessment
•   lt  The concentration on one ToR
• lt  The training of the staffs
• lt  a combination of these

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5. How to proceed in reality in China when using
ERM? (3)

• lt another concept is lead by a foreign expert
  to implement a risk working
• group on city - or provincial level
• lt this group can work out guidelines
• lt the foreign expert can train the group members

74
5. How to proceed in reality in China when using
ERM? (4)

• lt also, a good solution is to set up special
  sector risk working groups
• lt 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
76
Xiexie

• Contact me
• Contact wolf.kersten_at_gmx.de

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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

78
Abbreviations used (2)

• COO   Chief Operating Officer
• CP   Commercial Paper
• CRO   Chief Risk Officer
• CV   Curriculum Vitae
• ECUST  East China University of Science
  Technology
• EDP   Expert Data Pool
• e.g.    example given

79
Abbreviations used (3)

• ERM   Enterprise Risk Management
• EU   European Union
• EVA   Economic Value Added
• GDP   Gross Domestic Product
• G-20    Top 20 country leader meeting
• IFC   International Finance Corporation
• IT   Information Technology

80
Abbreviations used (4)

• MA   Mergers Acquisition
• MBA    Master of Business Administration
• MBS    Mortgage Backed Securities 
• MD   Managing Director
• Mio   Million (s)
• m-p-m   month per month
• PMS   Product-Market-Sales

81
Abbreviations used (5)

• QA   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

82
Abbreviations used (6)

• ToR   Types of Risks
• UK   United Kingdom
• US   United States
• USD    US Dollar currency
• USP    Unique Selling Proposition
• y-o-y   year on year