Risk Management Reporting in 2001 Survey of European Public Companies

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Risk Management Reporting in 2001Survey of
European Public Companies

• FERMA Conference Rome October 2003
• Students from Institut de Management des Risques
  (IMR) Bordeaux Business School
• Chris Lajtha Pierre Bordage
• Schlumberger Risk Insurance Management Team

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What Year ??

• The investor will be affected not by the
  net income, which he will actually receive from
  his investment in the long run, but by his
  expectations of such net income stream gt PV of
  future cash flows. These will often depend upon
  fashion, advertisement, or upon purely irrational
  waves of optimism or depression. Similarly, by
  risk we mean not the real risk as measured by the
  actual average of the class of investment over
  the period of years to which the expectation
  refers, but the risk as it is estimated, wisely
  or foolishly, by the investor. His desire that
  the net rate of interest should be as high as
  possible will be modified by the usually
  conflicting desire that the rate of risk shall be
  as low as possible. But no mathematical rule can
  be laid down respecting the exact compromise that
  will be struck between the fear of loss and the
  desire for a high rate of interest since the risk
  of which we must take account is subjective risk
  - its magnitude very largely depends on the
  amount of relevant information regarding the
  investment that is easily accessible to him. What
  would be a risky investment for an ignorant
  speculator may be exceptionally safe for the
  well-informed expert. The amount of risk to any
  investor practically depends upon the degree of
  his ignorance respecting the circumstances and
  prospects of the investment he is considering

Comment on Information Asymmetry In 1910 !!!
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FERMA Brief _at_ Sept 2002

• Design a workshop for the 2003 Rome Conference
  that requires the active involvement of the 20
  masters students at the Institut du Management
  des Risques one-year post-graduate course of
  the Bordeaux Business School.
• Find a topical risk management theme that can be
  enhanced with basic research and analysis by the
  masters students.

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Institut du Management des Risques
www.imr.bordeaux-bs.edu/
Bruce Roger Directeur Marie-Christine Desmartis
Prof. Finance
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Project theme selected Risk Management
Reporting in Europe in 2001

• The purpose of the study was to
• Analyse and compare the way certain large
  European companies communicated about risk and
  their risk management activities in their 2001
  annual reports.
• Propose a basis for the comparative analysis of
  future risk management reporting trends in Europe
  

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Why is Risk Management Reporting a Topical Theme?

• Changing Regulatory Authority requirements
• New European stock exchange disclosure
  requirements (eg Combined Code in UK NRE / COB
  Guidelines in France), and
• Certain national regulatory requirements (eg
  Sarbanes-Oxley Act in USA KonTraG law in
  Germany) with respect to adequacy of systems of
  internal control including tacit or explicit
  references to risk management
• Changing Market information requirements
• More explicit requests for information about
  risk management policies, capabilities,
  initiatives and performance from the investment
  community, generally

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Methodology 01

• A panel of 47 companies was selected for the
  purpose of this study. This selection was based
  on two main criteria
• Companies that raised capital on European stock
  exchanges in 2001 in anticipation that some
  comments about risk management would be reported
  and allowing for the possibility of comparable
  stock exchange reporting requirements
• Companies known to have corporate risk management
  functions in 2001 as evidenced, inter alia, by
  membership / participation in national risk
  management associations

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Methodology 02

• The analysis of the Annual Reports consisted in
  registering a score with respect to both quantity
  quality of risk risk management reporting
  against a generic reporting matrix - the
  Sustainability Reporting Guidelines of the GRI
  (Global Reporting Initiative).
• The GRI reporting guidelines provide a framework
  for reporting on organizations economic,
  environmental social performance - hence the
  usual reference to triple bottom line reporting
  a form of reporting on sustainable development.
  
• The present study was not designed to address the
  efficacy of the underlying risk management
  processes. It was concerned only with the nature
  of reporting relating to risk management
  initiatives. It has been assumed that reporting
  on environmental and/or social initiatives can be
  considered as a proxy for concern about /
  investment in risk management

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Methodology 03

• The analysis took into account both the
  traditional annual reports and also
  environmental, social and sustainability reports
  when such reports were available.
• Only about 150 companies use the GRI reporting
  framework around the world (and probably less in
  2001). However, the matrix
• Allows a broad analysis of the reporting of risk
  outside the traditional financial area
• Supports a benchmarking process - different
  companies in different market segments and at
  different times.
• Emerging, financial and non-financial reporting
  requirements tend to support the use of
  frameworks such as the GRI Sustainability
  Reporting Guidelines. Similar matrices can be
  used to chart individual company year-on-year
  risk management reporting trends.

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Global Reporting Initiative (GRI)
http//www.globalreporting.org/
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Caveats Assumptions

• Useful but not Useable
• Comparable over time trends and, to a limited
  extent only, space companies
• Qualitative rather than Quantitative not
  exactly repeatable
• Concerned only with the nature of reporting of
  performance, not on the underlying performance
  itself.
• Assumes that sustainability initiatives are
  closely allied / aligned to risk management
  initiatives
• Use of GRI Sustainability Reporting Guidelines
  for the provision of a matrix for analysing /
  comparing corporate reporting practices
• Limited number of companies per nationality /
  market segment

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Triple Bottom Line Reporting 01

• 1. Financial Performance
• Currency exchange exposure
• Interest rate exposure
• Commodity price exposure
• Liquidity adequacy / change
• Credit exposure
• Employee Benefit / Pension Funding exposure
• Effective tax rate / tax liability exposure

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Triple Bottom Line Reporting 02

• Environmental Performance
• Resource use
• Energy consumption
• Biodiversity
• Emissions
• Greenhouse gases / emissions
• Other emissions
• Discharges to water
• Waste
• Environmental Incidents / accidents
• Product cradle to grave stewardship /
  biodegradability

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Triple Bottom Line Reporting 03

• Social Performance
• Labour practices
• Health Safety
• Training and education
• Diversity and opportunity
• Human rights
• Community impact and investment
• Political / charitable donations / sponsorship
• Product stewardship consumer safety

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Scoring / Rating Assumptions

• Disclosure of financial exposures was relatively
  straightforward
• References to risk, uncertainty, and volatility
  were less evident with respect to environmental
  and social performance categories.
• Managing of waste emissions, product
  stewardship, health safety, human rights
  etcpresent significant sources of exposure to
  liability and perceived reputation both
  impairment and enhancement potential. Such
  exposures need to be included in any
  comprehensive, or enterprise, risk management
  perspective.
• The information reported (even if there was no
  specific reference to the words risk and risk
  management) was rated on the basis of both
  quantity and the credibility of the information
  reported.

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Scoring / Rating System

• 0 no mention at all and/or no credibility of
  reporting
• 1 minimalist reporting and/or low credibility
  of reporting
• 2 moderate reporting and/or average credibility
  of
• reporting
• 3 extensive reporting and/or high credibility
  of reporting
• When there was a material divergence in
  scores for quantum and credibility of reporting
  (e.g. extensive reporting 3 of low credibility
  1), then the credibility score was awarded more
  weight (in this example, the sub-category was
  scored 1).

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Data Capture Sheets
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Comparison by Country
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Country ComparisonRanges Most Diverse /
Consistent
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Comparison by Market Segment
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Market Segment ComparisonRanges Most Diverse /
Consistent
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Company ComparisonExtremes Highest 3 /
Lowest Scores 0
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Company ComparisonRanges Most Diverse /
Consistent
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NYSE Exposure vs. Purely European
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Risk Management Reporting Trend Drivers?

• Corporate Governance pressures for greater
  disclosure driven by concerns about the quality,
  timeliness and accessibility of company activity
  performance information
• Growing perception that Enterprise Risk
  Management facilitates company managements
  ability to both create sustainable value and
  communicate the value to stakeholders Extract
  from draft COSO ERM Framework _at_ July 2003
• Further stock exchange guidelines /or new
  accounting protocols addressing risk reporting
  disclosure requirements

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Corporate Governance - a framework, and stimulus,
for timely useful disclosure, appropriate
accountability, and effective risk management in
large, publicly-held companies
Corporate Governance Risk Management Reporting
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ICEAW - Consultation Draft - April 99 1
A companys system of internal control has, as
its principal aim, the management of risks that
are significant to the fulfilment of its business
objectives - with a view to safeguarding the
companys assets and enhancing, over time, the
value of the shareholders investment.

continued on next page
Extract from Internal Controls - Guidance
for Directors of Listed Companies Incorporated
in the United Kingdom
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ICEAW - Consultation Draft - April 99 2

• The Board should consider the following factors
  when assessing whether an internal control
  system is sound
• The nature and extent of the risks which it
  regards as acceptable for the company to bear
  within a particular business
• The threat of such risks becoming a reality
• If it happened, the companys ability to reduce
  the incidence and impact on the business
• The costs benefits related to operating
  relevant controls.

Extract from Internal Controls - Guidance
for Directors of Listed Companies Incorporated
in the United Kingdom
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UK Combined Code - published by London Stock
Exchange in June 1998 - led to the publication of
the Turnbull Guidelines in 99/00 which address
the internal control management systems risk
management
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Germany - KonTraG law - listed non-listed AGs

• Requirement for the Management Board to
  implement an appropriate risk management system
• Structure of the risk management system depends
  on the industry, size and structure of company
• Requirement for parent company to implement a
  group-wide risk management system
• Management Report must detail the risks
  attaching to the expected future developments of
  the company
• Deliberate lack of prescriptive guidance
• Mandatory for financial years commencing after
  31 Dec 98

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USA Sarbanes-Oxley Act Section 404 July 2002
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France NRE COB Guidelines