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Topic : Operational Risk
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Industry : Management & Strategy Consulting
Functional Area : Valuation
Activity: Question posted: 06 02 2008 23:30:49 +0000, 2 answers, 172 views, last activity 07 06 2010 20:18:08 +0000
 
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  Answered by     sachin , Team Leader -(NonTechnical), Infor Global Solutions  | 06 18 2008 23:37:28 +0000
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Steven Minsky, a risk expert, highlights the differences between traditional Risk Management and true Enterprise Risk Management, which most importantly is about helping something happen - not preventing something from happening. Steven's blog helps you think about risk in a new way and how to benefit practically from this rapidly evolving new field.
February 19, 2008
Risk Management: Evolve or Step Aside

The business environment evolves, organizations evolve and people’s roles and contributions must evolve as well. Some risk managers have expressed frustration due to insufficient resources or support from senior management. Risk managers who have an active role in financial reporting compliance activities (e.g., SOX 404) however, find their departments’ visibility and influence within the organization high. Such was the case at Alfa Corporation.

This month’s Treasury & Risk Magazine cover story, Audit Busters, explains the business case for the CRO partnering with the CFO at Alfa Corporation resulting in the transformation of their compliance programs to serve their business strategy while reducing their external audit hours by 60% at the same time.

With the right ERM infrastructure, the CRO can now offer your CFO the capability to manage tomorrow’s financial surprises today while there is still time to change the outcome. New AS5 legislation that mandates a top–down, risk–based approach provides risk managers with the opportunity to deliver measurable financial and strategic value while building the right ERM infrastructure that easily extends to all areas of the business.

The stakes are high:
If history repeats itself, according to CFO magazine, How a Material Weakness Can Cost You, more than 11 percent of companies with financial reporting and compliance programs will be found to have material weaknesses. And about 86 percent of material weaknesses will be discovered not by management or consultants but by external auditors. The consequences are real. Companies affected see more than a 4 percent drop in stock price; their CFOs face a 62 percent likelihood of being replaced; and a 150 percent plus jump in ongoing external audit fees.

As problems like these mount, CFOs are beginning to realize that an ERM-based SOX effort works much better than a controls-based SOX effort or an ad hoc approach to risk.

  Answered by     Jitena Kumar Rawat, Senior Consultant, GKC  | 06 02 2008 23:38:56 +0000
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Financial risk management consists of activities in which a measurable risk can be mitigated by entering into some sort of financial transaction. The transaction might be achievable by purchasing insurance, buying (or selling) a futures contract, buying options, or through some other means. An example might be an airline that buys oil futures contracts to manage the risk of future fluctuations in the price of jet fuel. Financial risk management is the narrowest definition of risk management.

Operational risk management addresses risks that are beyond (but may very well include) those within the definition of financial risk management. As one example, manufacturing firms may build plants in foreign countries as a way to offset operational risks. One of the risks managed is currency risk if the plant's products are largely sold in the country in which they are manufactured. Financial risk management is typically a subset of operational risk management, although there may be instances in which financial risk management can be utilized to more cheaply manage a risk than it can be managed through operational mechanisms. A good example is buying oil futures is a cheaper way for airlines to manage jet fuel price risk than buying jet fuel in advance and storing it (although the storage solution addresses an operational risk associated with running out of fuel).

Enterprise risk management (ERM) is a much broader arena of risk management, and encompasses financial and operational risk management. ERM also includes human capital risk (look at what happened at Societe Generale because one trader felt he needed to prove himself), strategic and reputational risk, as well as other hazards.
An efficative enterprise risk management system will have three levels of risk mitigation: business processes, contracts and insurance. I have seen too many organizations that have had to use their insurance coverage because they failed to properly address risk at the business process level.

You are correct in linking financial and operational processes. While the former are very important (e.g. customer billing, payroll, derivatives), it's the operational processes (shipping, production, customer service) that drive the business. In any case, process risk should be assessed in the context of company policies (what should occur) and how the process actually works, through walkthroughs, mapping and interviews. Identifying risks and comparing them to controls in place allows for the prioritzation of gaps to be addressed.

As you can see, the most effective way of linking operational (drivers) and financial (results) throughout the enterprise is at the process level. Of course, this bottom-up approach will only work with top management buy-in to a clear framework.

 
 
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