- What is Corporate Governance ?
- What is Risk Management ?
- How do they intersect ?
- Why is Risk Governance important ?
- What is consequence of failure?
- What to do or how do we respond ?
It is defined in ISO 31000 as the effect of uncertainty on objectives (whether positive or negative) followed by coordinated and economical application of resources to minimize, monitor, and control the probability and/or impact of unfortunate events or to maximize the realization of opportunities.
Risk management is the identification, assessment, and prioritization of risks.
Key Issues
•Probability (Likelihood) of event occurring,
•Severity (Impact) of the event on set objectives.
The strategies to manage risk typically include transferring the risk to another party, avoiding the risk, reducing the negative effect or probability of the risk, or even accepting some or all of the potential or actual consequences of a particular risk.
Credit Risk - Credit risk is most simply defined as the potential that a bank borrower or counterparty will fail to meet its obligations in accordance with agreed terms.
Market Risk - Market risk refers to the risk of loss to an institution resulting from movements in market prices, in particular, changes in interest rates, foreign exchange rates, and equity and commodity prices.
Operational Risk – This is the risk of loss resulting from inadequate or failed internal processes, people and systems, or from external events.
What happens when it fails?
ENRON – Before bankruptcy in December 2001, one of global leading power, energy & utilities companies - employed 20,000 staff. “A” rated. Was one of Fortune’s Top 100 companies to work for in America in 2000. Creative accounting. Chairman Ken Lay; CEO – Jeff Skilling; CFO – Andrew Fastow. Placed liabilities in shell companies – not appear in books. Fraudulent deals - Also led to demise of Arthur Andersen. Partly led to Sarbanes Oxley Act of 2002 (Public Company Accounting and Investor Protection Act). Corporate Governance rules – responsibility of directors; criminal penalties etc.
WorldCom – was America’s second largest long distance phone company (after AT & T). CEO Bernard Ebbers; CFO Scott Sullivan; Comptroller David Myers – aggressive growth strategy – tried to merge with Sprint in 2000. Not approved by regulators. Fraudulent Financial records from mid-1999 to 2002 – booking interconnectivity costs as capital instead of expenses and inflating revenues. Internal auditors unearthed $3.8BN in fraud. Arthur Andersen withdrew opinion. Bankruptcy July 2002.
Lehman Brothers – Founded 1850. Fourth largest investment bank in US (after Goldman Sachs; Morgan Stanley and Merrill Lynch). Declared bankruptcy September 2008. following large exodus of clients; drastic losses in stock and downgrade of assets by credit rating agencies. Largest bankruptcy in US history! Holdings shared between Barclays (NA divisions) and Nomura (Asia-Pac, Europe and Middle East). Financial accounting gimmicks; sub-prime mortgage bets (large positions in securities backed by lower rated mortgages). In first half of 2008, lost 73% of value as credit markets continued to tighten – had to sell of $6bn of assets and lost $2.8bn.
Bear Stearns – Founded 1923. Issued large amounts of asset-backed securities including mortgages (by Lewis Ranieri – “father of mortgage securities”). As losses mounted in 2006 and 2007, company actually increased exposure especially to mortgage backed securities which were central to sub-prime crisis. Sold to JP Morgan for $10/share from 52 week pre-crisis high of $133.20.
Barings Bank – Oldest merchant bank in London (founded 1762) until collapse in 1995 after loss from unauthorized speculative trades by its Head Derivatives Trader, Nick Leeson in Singapore – lost GBP827m. Instead of buying and simultaneously selling, Leeson held on to the contract, gambling on future direction of Japanese markets. Internal challenges – doubled as both floor manager and head of settlement operations. No check and balance.
Societe Generale – Jerome Kerviel – caused Eur4.9bn ($6.1bn) trading loss in 2008. one of largest in history. Arbitraging between equity derivatives and cash equity prices. Wiped off almost two years of pre-tax profits of SG’s investment banking unit. Taking unhedged positions far in excess of desk limits up to Eur 49.9bn (in excess of bank’s total market cap) – disguising exposure with fake hedges. Highlights lack of risk experts on risk committees. States making a profit makes hierarchy turn blind eye
J.P Morgan – Losses on Trading/derivatives bet – Made by CIO in London – invests excess deposits to create interest rate hedge – brought in $4bn over last 3 years. Estimates could reach as much as $6bn - $9bn (versus Q1 profit of $5.4bn). CEO Jamie Dimon under pressure. Pay of responsible officers to be docked – little real impact.
Barclays – Rate-rigging scandal brought down CEO, Bob Diamond. Fined GBP290m (approx $450m). Possible criminal prosecution. Glass-Steagall type action possible (division between investment and commercial banking). CEO lost $30m bonus
RBS – IT glitch caused breakdown of service to customers – could they have tested on one of their brands or regionally before full rollout? Also fighting to keep LIBOR records private – rate fixing scandal.
So who is to save us?
–Board
–Executive Management
–Internal Audit
–Accounting firms
–Rating agencies
–Regulators
All have failed.