The Hindu Business Line : Do our companies understand financial risk?

India Inc. is going global. They are acquiring much larger competitors, aggressively entering new markets and exploring various financial tools. But the moot question is whether they can manage the risks that emanate from such moves.

Intense global competition and rapid growth are forcing Indian firms to examine corporate enterprise risk management (ERM) elsewhere, especially in Europe, Australia and North America, where the process is more mature, concludes a report by The Conference Board ( www.conference-board.org ), a non-partisan and not-for-profit business membership and research organisation.

While Tata Motors, ICICI Bank, Tata Chemicals and Dr Reddy’s, represent case studies for The Conference Board by virtue of their use of ERM as a management tool, most of the Indian firms generally do not take such a comprehensive approach.

Agrees Mr Richard Rekhy, Chief Operating Officer of consultancy firm KPMG (one of the sponsors of the report titled Assessing the Climate for Enterprise Risk Management in India). “The risk management procedures being currently followed tend to be reactive than proactive,” he told Business Line in course of an exclusive e-mail interview.

The recent fiasco over forex derivatives split the corporate sector in two halves. On one side, companies questioned the soundness of the financial risks taken on their behalf by banks; while on the other, lenders defended themselves vociferously.

Referring to the issue, Mr Rekhy was quick to observe that “this indicates a need for better understanding of risk management practices and sensitivity models to be able to take informed decisions after proper appreciation of impact, if even a remote risk was to materialise due to external factors.”

Excerpts:

Do Indian companies understand financial risk? What is the state of risk management among India companies?

While companies understand the concept and related implications of traditional financial risks managed historically, knowledge and awareness of financial risks associated with new and complex financial transactions are evolving. Companies need to focus on these risks and understand the long-term implications, especially in a volatile market environment.

Generally the present state is more in form and not in spirit. Companies need to move away from a compliance-driven approach to a more structured approach, which will help them in a complex business environment to meet competitive pressures.

Apropos to recent forex derivative issue in India, is there a case to be made out of even financial intermediaries not being able to properly gauge risk?

The current model followed generally allows for normal market conditions. New financial models as such are new in India; hence these require to be studied in that context.

This indicates a need for better understanding of risk management practices and sensitivity models to be able to take informed decisions after proper appreciation of impact if even a remote risk was to materialise due to external factors. It also indicates that companies entering into these transactions consider strong policies for delegation of authority and limits, and risk management practices.

For financial intermediaries, perhaps it may be an opportunity to consider if any changes are necessary for customer management and marketing practices to have better enterprise risk management practices for their own organisations.

The ERM report includes case studies of the four biggest Indian firms which have decent risk management systems in place. What sets them apart from the rest?

These are among the initial group of Indian companies that align their risk management systems to practices adopted in matured economies. Stakeholders and regulators in the global markets they operate in are highly sensitive to adverse issues and also give increased importance to governance practices adopted by these companies. As a result, these companies need to ensure that their risk management and governance practices factor in stakeholder and regulator expectations.

Generally a company, which has good risk management procedures in place, can take more risks and hence look at better rewards. Markets also reward companies that have good risk management procedures through better valuations.

Recently, Standard & Poor came out with criteria for rating companies, which now include ERM procedures. All publicly issued debts will be under this scrutiny. Companies would need to gear themselves up with good risk management procedures to get better ratings and hence reduce their cost of capital.

Non-financial companies have underdeveloped, or sometimes non-existent, risk measurement metrics. What would be the best way to progress for them so as to build a hedge from risk environment?

Non-financial organisations should view ERM more as a business need, than a compliance need. Traditionally they have been managing risk as part of their day-to-day business operations.

However, there is a need for them to now formalise their risk management procedures. They need to begin with a baseline ERM framework/structure and then continuously enhance the same in line with leading practices and organisation growth. Finally, the companies have to be able to measure risks. This would also require collection of historical data.

Is there a feeling of reactive ERM being currently in use, rather than of the proactive kind?

As ERM is still an evolving concept in India, the risk management procedures being currently followed tend to be reactive than proactive. However organisations are evaluating various key business risks proactively during their business planning process.

They need to now adopt a formal and structured approach to ensure that all risks and related mitigation measures are evaluated comprehensively.

Organisations also need to focus on improving their risk monitoring/performance measures with an aim to identify risk exposures and evaluate the effectiveness of mitigation measure well in advance rather than managing the implications on a reactive basis.

In risk, some see opportunity. The report says that Indian companies have been focusing on the downside. How can ERM help profit?

The other side of risk is the opportunity that can be leveraged. Risk is inherent in all business activities and operations. If the management has adequate procedures and information to evaluate the risk exposure and benefits (both short term and long term), they can take calculated risks (as per their risk appetite) through which the organisation can gain.

How come good risk management procedures did not alert the companies on recent failures?

Many companies may have a good risk management procedure in place; but there is another important element, i.e., governance. If issues raised by risk management get overridden, there is nothing much that any risk management programme can do. Hence, good risk management procedures need to be backed by good governance. What needs to be studied for many of these organisations is whether it is risk management failures or governance failures.

How do we spread risk management in corporate India?

While some of the larger companies have adopted good risk management procedures, it is more of the mid-size companies which need to be made aware of this rather new method of helping them grow through putting good risk management procedures in place.

Why do cars have brakes? This is to enable the cars to move faster, similarly good risk management procedure help companies grow faster as they can see better and broader range of opportunities.

D. MURALI

KUMAR SHANKAR ROY

http://AccountSpeak.blogspot.com

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