Table of Contents

Cover

Series

Title

Foreword

PART I: Overview

CHAPTER 1: Enterprise Risk Management: An Introduction and Overview
1. WHAT IS ENTERPRISE RISK MANAGEMENT?
2. DRIVERS OF ENTERPRISE RISK MANAGEMENT
3. SUMMARY OF THE BOOK CHAPTERS
4. FUTURE OF ERM AND UNRESOLVED ISSUES
5. NOTES
6. ABOUT THE EDITORS
CHAPTER 2: A Brief History of Risk Management
1. INTRODUCTION
2. RISK MANAGEMENT IN ANTIQUITY
3. AFTER THE MIDDLE AGES
4. THE PAST 100 YEARS
5. NOTES
6. ABOUT THE AUTHOR
CHAPTER 3: ERM and Its Role in Strategic Planning and Strategy Execution
1. RISING EXPECTATIONS FOR STRATEGIC RISK MANAGEMENT
2. INTEGRATING RISK INTO STRATEGIC PLANNING
3. CREATING A STRATEGIC RISK MINDSET AND CULTURE
4. BUILDING A STRATEGIC RISK ASSESSMENT PROCESS
5. CONCLUSION
6. NOTES
7. ABOUT THE AUTHORS
CHAPTER 4: The Role of the Board of Directors and Senior Management in Enterprise Risk Management
1. INTRODUCTION
2. GOVERNANCE EXPECTATIONS FOR BOARD OVERSIGHT OF RISK MANAGEMENT
3. DELEGATION OF RISK OVERSIGHT TO BOARD COMMITTEES
4. FORMALIZING RISK MANAGEMENT PROCESSES
5. SENIOR EXECUTIVE LEADERSHIP IN RISK MANAGEMENT
6. THE ROLE OF THE INTERNAL AUDIT FUNCTION IN ERM
7. EXTERNAL AUDIT AS AN INDEPENDENT SOURCE OF KEY RISK IDENTIFICATION
8. ERM IMPLEMENTATION STRATEGIES
9. CONCLUSION
10. NOTES

PART II: ERM Management, Culture, and Control

CHAPTER 5: Becoming the Lamp Bearer: The Emerging Roles of the Chief Risk Officer
1. THE ORIGINS OF THE CRO
2. THE CRO AS COMPLIANCE CHAMPION
3. THE CRO AS MODELING EXPERT
4. THE CRO AS STRATEGIC CONTROLLER
5. THE CRO AS STRATEGIC ADVISOR
6. WHICH CRO ROLE TO PLAY?
7. CONCLUSION
8. NOTES
9. REFERENCES
10. ACKNOWLEDGMENTS
11. ABOUT THE AUTHOR
CHAPTER 6: Creating a Risk-Aware Culture
1. THE IMPORTANCE OF CULTURE
2. ELEMENTS OF A RISK-AWARE CULTURE
3. HOW TO CREATE A RISK-AWARE CULTURE
4. WHAT DOES RISK MANAGEMENT HAVE TO DO?
5. CONCLUSION
6. REFERENCES
7. ABOUT THE AUTHOR
CHAPTER 7: ERM Frameworks
1. INTRODUCTION
2. ELEMENTS OF AN ERM FRAMEWORK
3. RISK MANAGEMENT PROCESS (RMP)
4. MANDATE AND COMMITMENT TO THE ERM FRAMEWORK
5. RISK MANAGEMENT POLICY
6. INTEGRATION OF RISK MANAGEMENT AND RESOURCES FOR ERM
7. COMMUNICATIONS, CONSULTATION, AND REPORTING
8. ACCOUNTABILITY
9. CONTINUOUS IMPROVEMENT
10. CONCLUSION
11. REFERENCES
12. ABOUT THE AUTHOR
CHAPTER 8: Identifying and Communicating Key Risk Indicators
1. INTRODUCTION
2. WHAT IS A KEY RISK INDICATOR?
3. PRACTICAL APPLICATIONS
4. VALUE OF KRIs TO RISK MANAGEMENT
5. DESIGN PRINCIPLES
6. IMPLEMENTATION CONSIDERATIONS
7. CONCLUSION
8. NOTE
9. ACKNOWLEDGMENT
10. ABOUT THE AUTHOR

PART III: ERM Tools and Techniques

CHAPTER 9: How to Create and Use Corporate Risk Tolerance
1. INTRODUCTION
2. WHAT IS RISK TOLERANCE?
3. WHY IS SETTING RISK TOLERANCE IMPORTANT?
4. WHAT ARE THE FACTORS TO CONSIDER IN SETTING RISK TOLERANCE?
5. HOW CAN YOUR ORGANIZATION MAKE RISK TOLERANCE USEFUL IN MANAGING RISK?
6. CONCLUSION
7. NOTES
8. ABOUT THE AUTHORS
CHAPTER 10: How to Plan and Run a Risk Management Workshop
1. INTRODUCTION
2. WHAT IS A RISK WORKSHOP?
3. WHY USE WORKSHOPS?
4. HOW TO CONDUCT A RISK WORKSHOP
5. PREPARATION
6. EXECUTION
7. TECHNIQUES FOR PLANNING AND FACILITATING EFFECTIVE RISK WORKSHOPS
8. CONCLUSION
9. ABOUT THE AUTHOR
CHAPTER 11: How to Prepare a Risk Profile
1. INTRODUCTION
2. DEFINITION AND USES OF A CORPORATE RISK PROFILE
3. COMMON TYPES OF CORPORATE RISK PROFILES
4. ADVANTAGES AND DISADVANTAGES OF INFORMATION-GATHERING METHODOLOGIES
5. HOW TO PREPARE A “TOP 10” RISK PROFILE—HYDRO ONE’S EXPERIENCE
6. CONCLUSION
7. NOTES
8. REFERENCES
9. ABOUT THE AUTHOR
CHAPTER 12: How to Allocate Resources Based on Risk
1. INTRODUCTION
2. RISK POLICY AND A CENTER OF EXCELLENCE FOR RISK MANAGEMENT
3. THE CONSEQUENCE DOMAIN
4. RISK-BASED BUSINESS PROCESSES AND ORGANIZATIONAL CONSIDERATIONS
5. CONCEPTS, METHODS, AND MODELS ENABLING RISK IDENTIFICATION, EVALUATION, MITIGATION, PRIORITIZATION, AND MANAGEMENT
6. INFORMATION REQUIREMENTS AND CHALLENGES
7. MEASURES OF EFFECTIVENESS FOR CONTINUOUS IMPROVEMENT
8. CONCLUSION
9. NOTES
10. ABOUT THE AUTHOR
CHAPTER 13: Quantitative Risk Assessment in ERM
1. INTRODUCTION
2. RISK ASSESSMENT: FOUR ALTERNATIVE APPROACHES
3. AGGREGATING PROBABILITIES AND IMPACTS
4. TOTAL CORPORATE RISK: AN ILLUSTRATION
5. INCORPORATING RISK QUANTIFICATION IN THE BUSINESS PLANNING PROCESS
6. SENSITIVITIES AND SCENARIOS
7. CONCLUSION
8. NOTES
9. REFERENCES
10. ABOUT THE AUTHOR

PART IV: Types of Risk

CHAPTER 14: Market Risk Management and Common Elements with Credit Risk Management
1. INTRODUCTION TO CREDIT RISK AND MARKET RISK
2. RESPONDING TO CREDIT AND MARKET RISK
3. MEASURING MARKET RISK
4. MARKET RISK MANAGEMENT WITH FORWARD-TYPE PRODUCTS
5. CONCLUSION
6. NOTES
7. REFERENCES
8. ABOUT THE AUTHOR
CHAPTER 15: Credit Risk Management
1. CREDIT RISK ANALYSIS
2. AN ANALYSIS OF THE CREDIT CRISIS
3. CONCLUSION
4. NOTES
5. REFERENCES
6. ABOUT THE AUTHOR
CHAPTER 16: Operational Risk Management
1. INTRODUCTION
2. WHAT IS OPERATIONAL RISK AND WHY SHOULD YOU CARE ABOUT IT?
3. IS RISK ALL BAD?
4. HOW DO YOU ASSESS OPERATIONAL RISKS, PARTICULARLY IN A DYNAMIC BUSINESS ENVIRONMENT?
5. WHY YOU NEED TO DEFINE RISK TOLERANCE FOR ALIGNED DECISION MAKING
6. WHAT CAN YOU DO TO EFFECTIVELY MANAGE OPERATIONAL RISK?
7. HOW DO YOU ENCOURAGE A CULTURE OF RISK MANAGEMENT AT THE OPERATIONAL LEVEL?
8. HOW DO YOU ALIGN OPERATIONAL RISK MANAGEMENT WITH ENTERPRISE RISK MANAGEMENT?
9. CONCLUSION
10. NOTES
11. ABOUT THE AUTHOR
CHAPTER 17: Risk Management: Techniques in Search of a Strategy
1. INTRODUCTION
2. CURRENT SITUATION
3. RISK STRATEGY FRAMEWORK
4. GOVERNANCE
5. NEW DIRECTIONS
6. CONCLUSION
7. NOTES
8. REFERENCES
9. ABOUT THE AUTHOR
CHAPTER 18: Managing Financial Risk and Its Interaction with Enterprise Risk Management
1. INTRODUCTION
2. WHAT IS FINANCIAL RISK AND HOW IS IT MANAGED?
3. THEORETICAL UNDERPINNINGS OF FINANCIAL HEDGING AND EMPIRICAL FINDINGS
4. INTERACTION OF FINANCIAL HEDGING WITH OTHER TYPES OF RISK MANAGEMENT
5. WHAT CAN WE LEARN ABOUT ERM GIVEN OUR KNOWLEDGE OF FINANCIAL HEDGING?
6. NOTES
7. REFERENCES
8. ABOUT THE AUTHOR
CHAPTER 19: Bank Capital Regulation and Enterprise Risk Management
1. INTRODUCTION
2. THE EVOLUTION OF BANK CAPITAL REQUIREMENTS
3. CONCLUSION
4. NOTES
5. REFERENCES
6. ABOUT THE AUTHOR
CHAPTER 20: Legal Risk Post-SOX and the Subprime Fiasco: Back to the Drawing Board
1. INTRODUCTION
2. THE LEGAL FRAMEWORK OF LEGAL AND REPUTATIONAL RISK MANAGEMENT
3. AN ASSESSMENT OF THE SOX FRAMEWORK ON LEGAL AND REPUTATIONAL RISK
4. TOWARD OPTIMAL REPUTATIONAL AND LEGAL RISK MANAGEMENT
5. CONCLUSION
6. NOTE
7. REFERENCES
8. ABOUT THE AUTHOR
CHAPTER 21: Financial Reporting and Disclosure Risk Management
1. THE IMPORTANCE OF DISCLOSURE MANAGEMENT AND ERM
2. FOUNDATIONS IN THE UNITED STATES
3. DISCLOSURE AND SARBANES-OXLEY
4. IMPORTANT SOX SECTIONS
5. OTHER FINANCIAL REPORTING
6. RISK IDENTIFICATION, MONITORING, AND REPORTING
7. FINANCIAL REPORTING CHALLENGES TODAY
8. CONCLUSION
9. NOTES
10. REFERENCES
11. ABOUT THE AUTHOR

PART V: Survey Evidence and Academic Research

CHAPTER 22: Who Reads What Most Often?: A Survey of Enterprise Risk Management Literature Read by Risk Executives
1. INTRODUCTION
2. SURVEY METHODOLOGY
3. SURVEY RESULTS
4. CONCLUSION
5. APPENDIX 22.A: PUBLICATIONS INCLUDED IN THE SURVEY
6. APPENDIX 22.B: SURVEY RESPONDENTS WHO GAVE PERMISSION TO BE IDENTIFIED
7. NOTES
8. REFERENCES
9. ABOUT THE AUTHORS
CHAPTER 23: Academic Research on Enterprise Risk Management
1. INTRODUCTION
2. ACADEMIC RESEARCH ON ENTERPRISE RISK MANAGEMENT
3. CASE STUDIES ON ERM
4. CONCLUSION
5. NOTES
6. REFERENCES
7. ABOUT THE AUTHORS
CHAPTER 24: Enterprise Risk Management Lessons from the Field
1. INTRODUCTION
2. LESSONS FROM THE ERM PROCESS
3. LESSONS FROM INTEGRATING ERM WITH ONGOING MANAGEMENT INITIATIVES
4. SOME KEY VALUE LESSONS FROM ERM
5. CONCLUSION
6. NOTES
7. REFERENCES
8. FURTHER READING
9. ABOUT THE AUTHORS

PART VI: Special Topics and Case Studies

CHAPTER 25: Rating Agencies’ Impact on Enterprise Risk Management
1. INTRODUCTION
2. BANKING: GENERAL
3. INSURANCE: S&P
4. INSURANCE: MOODY’S
5. INSURANCE: FITCH
6. INSURANCE: A.M. BEST
7. U.S. ENERGY COMPANIES: S&P
8. NONFINANCIAL COMPANIES: S&P
9. A FLY IN THE OINTMENT
10. CONCLUSION
11. NOTES
12. FURTHER READING
13. ABOUT THE AUTHOR
CHAPTER 26: Enterprise Risk Management: Current Initiatives and Issues
1. QUESTION 1
2. QUESTION 2
3. QUESTION 3
4. QUESTION 4
5. QUESTION 5
6. QUESTION 6
7. QUESTION 7
8. QUESTION 8
9. NOTES
CHAPTER 27: Establishing ERM Systems in Emerging Countries
1. INTRODUCTION
2. ENTERPRISE RISK MANAGEMENT AND ITS BENEFITS IN EMERGING MARKETS
3. OBSERVATIONS OF ERM PRACTICES IN EMERGING COUNTRIES
4. CONCLUSION
5. APPENDIX: COSO APPROACH TO ENTERPRISE RISK MANAGEMENT
6. NOTES
7. REFERENCES
8. ABOUT THE AUTHOR
CHAPTER 28: The Rise and Evolution of the Chief Risk Officer: Enterprise Risk Management at Hydro One
1. HYDRO ONE
2. GETTING STARTED WITH ERM
3. PROCESSES AND TOOLS
4. CORPORATE RISK PROFILE
5. QUANTIFYING THE UNQUANTIFIABLE
6. BENEFITS OF ERM AND OUTCOMES AT HYDRO ONE
7. CONCLUSION
8. NOTES
9. ABOUT THE AUTHORS

Index

End User License Agreement

List of Tables

CHAPTER 5: Becoming the Lamp Bearer: The Emerging Roles of the Chief Risk Officer

Exhibit 5.1 Summary of the Business-Partner Roles of the CRO

CHAPTER 7: ERM Frameworks

Exhibit 7.1 An ISO 31000 Compatible Framework for Implementing ERM Including the Risk Management Process

CHAPTER 8: Identifying and Communicating Key Risk Indicators

Exhibit 8.1 Examples of KRIs
Exhibit 8.2 KRIs at Different Levels of Granularity
Exhibit 8.3 KRIs Are Linked to Risk, Performance, and Strategy
Exhibit 8.4 KRI Is a Component of a Larger Risk Assessment Process
Exhibit 8.5 KRIs Help to Clarify Risk-Taking Expectations
Exhibit 8.6 KRIs Provide Tangible Measures to Trigger Action
Exhibit 8.7 Sources of Information to Designing KRIs
Exhibit 8.8 Accountability for KRIs

CHAPTER 9: How to Create and Use Corporate Risk Tolerance

Exhibit 9.1 Private-Sector Organization versus Public-Sector Organization
Exhibit 9.2 Risks for Private-Sector versus Public-Sector Organizations

CHAPTER 10: How to Plan and Run a Risk Management Workshop

Exhibit 10.1 How to Conduct a Risk Workshop
Exhibit 10.2 Setting Workshop Objectives
Exhibit 10.3 Sample Risk Magnitude Scale
Exhibit 10.4 Sample Probability Scale
Exhibit 10.5 Sample “Strength of Mitigants” Scale
Exhibit 10.6 Sample Record-Keeping Template

CHAPTER 11: How to Prepare a Risk Profile

Exhibit 11.1 Risk Map—December 2006
Exhibit 11.2 Heat Map
Exhibit 11.3 Risk Information Gathering Alternatives
Exhibit 11.4 Risk Profile—Interview Sheet
Exhibit 11.5 Risk Profile Matrix
Exhibit 11.6 The Evolution of Asset Risks

CHAPTER 12: How to Allocate Resources Based on Risk

Exhibit 12.1 Major Business Frameworks for Achieving Business Objectives
Exhibit 12.2 SBO/KPI/RT Hierarchy
Exhibit 12.3 Strategic Business Objectives and Key Performance Indicator Relationship
Exhibit 12.4 Key Performance Indicators and Risk Tolerance Relationships
Exhibit 12.5 Key Performance Indicator/Planning Indicator/Risk Tolerance Relationship
Exhibit 12.6 Representative Categories and Probability Levels for Assigning Probabilities to Risk Events
Exhibit 12.7 Risk Space Concept for Identifying Business Risks
Exhibit 12.8 Key Process Steps of the RFRAF
Exhibit 12.9 Key Elements and Products of the Risk-Based Business Processes
Exhibit 12.10 Business Functions Typically Involved in Business Planning and Risk Assessments
Exhibit 12.11 Time Frames and Information Contributions to Risk Assessments
Exhibit 12.12 Graphical Representation of Prioritization Model Output

CHAPTER 13: Quantitative Risk Assessment in ERM

Exhibit 13.1 Impact Range Probability Distribution
Exhibit 13.2 Methods of Quantifying Risk
Exhibit 13.3 An Example of a Two-Dimensional Risk Map
Exhibit 13.4 An Example of a Probability Scale
Exhibit 13.5 An Example of an Impact Scale
Exhibit 13.6.A Adding Expected Losses
Exhibit 13.6.B Calculating the Distribution of Combined Impacts
Exhibit 13.7 Medium-Term Total Corporate Risk of a Housing Association (Prior to Risk-Management Actions)

CHAPTER 14: Market Risk Management and Common Elements with Credit Risk Management

Exhibit 14.1 Histogram of Potential Earnings
Exhibit 14.2 Comparison of Spot, Forward, and Option Hedging Strategies

CHAPTER 15: Credit Risk Management

Exhibit 15.1 Recovery Rates on Corporate Bonds as a Percentage of Face Value 1982–2003
Exhibit 15.2 One-Year Transition Matrix—Percentages Moody’s 1970–2006
Exhibit 15.3 Structure of a CDO

CHAPTER 16: Operational Risk Management

Exhibit 16.1 Where the Performance Goes
Exhibit 16.2 The Bowtie Model
Exhibit 16.3 Examples of the Relationship Between a Risk Factor, Risk Event, and Consequence
Exhibit 16.4 Bowtie Example
Exhibit 16.5 Risk Treatment Selection Criteria
Exhibit 16.6 Alignment Between Enterprise and Operational Risk Management

CHAPTER 17: Risk Management: Techniques in Search of a Strategy

Exhibit 17.1 Value Implications of Risk Appetite Changes
Exhibit 17.2 Gross Leverage Levels (Total assets divided by total shareholders’ equity)
Exhibit 17.3 Drivers of Risk Management Strategy
Exhibit 17.4 Risk Appetite Continuum
Exhibit 17.5 Risk Appetite and Value Creation
Exhibit 17.6 Asset Price Liquidity
Exhibit 17.7 DAR Control Framework
Exhibit 17.8 Firm and Its Environment
Exhibit 17.9 Adaptive Risk Management

CHAPTER 18: Managing Financial Risk and Its Interaction with Enterprise Risk Management

Exhibit 18.1 Examples of Contracts Traded at Major U.S. Futures Exchanges

CHAPTER 19: Bank Capital Regulation and Enterprise Risk Management

Exhibit 19.1 U.S. Bank Equity/Asset Ratios
Exhibit 19.2 Basel II - Minimum Capital for a $100 Commercial Loan
Exhibit 19.3 Regulatory Arbitrage: Two Loans for $1 Million Each
Exhibit 19.4 Economic Capital

CHAPTER 21: Financial Reporting and Disclosure Risk Management

Exhibit 21.1 Recent Firm Failures and Disclosure Management
Exhibit 21.2 ERM Dashboard

CHAPTER 22: Who Reads What Most Often?: A Survey of Enterprise Risk Management Literature Read by Risk Executives

Exhibit 22.1 Industry Affiliation of Survey Respondents
This graphic lists the number of firms and the percentage of total firms by industry that responded to the survey.
Exhibit 22.2 Experience with Enterprise Risk Management
Exhibit 22.3 Drivers for Implementing Enterprise Risk Management
Exhibit 22.4 Extent of Following COSO’s ERM Recommended Tools and Techniques This graph lists the responses to the question: To what extent do you follow COSO’s ERM recommended tools and techniques?
Exhibit 22.5 Usefulness of Sources of Best Practices and Methodology for ERM
This graph lists the mean response rating to the question: How useful are the following sources of best practices and methodology for ERM? Ratings response categories were: 1=Seldom, 2=Fair/Occasional, 3=Good/Frequent, and 4=As much as Possible.
Exhibit 22.6 Mean Ratings of Publications Used in Survey
Exhibit 22.7 Top 10 Articles
Exhibit 22.8 Top 10 Books
Exhibit 22.9 Top 11 Research Reports
Exhibit 22.10 Other Useful Literature for the Implementation of ERM Not Included in the Survey

CHAPTER 23: Academic Research on Enterprise Risk Management

Exhibit 23.1 Academic Research on Entreprise Risk Management-Research Articles
Exhibit 23.2 Academic Research on Enterprise Risk Management—Case Studies

CHAPTER 24: Enterprise Risk Management: Lessons from the Field

Exhibit 24.1 Business Risk Model—A common Language
Exhibit 24.2 Industry Risk Portfolio
Exhibit 24.3 Qualitative and Quantitative Approaches to Assessment and Measurement
Exhibit 24.4 Risk Map
Exhibit 24.5 Risk Map
Exhibit 24.6 Strategy, the Balanced Scorecard, and the Budget
Exhibit 24.7 Risk Management in Acquisitions
Exhibit 24.8 Balanced Scorecard and Strategic Risk Assessment
Exhibit 24.9 Corporate Governance and ERM

CHAPTER 26: Enterprise Risk Management: Current Initiatives and Issues

Exhibit 26.1 The Four Pillars of BU NA’s ERM Program

CHAPTER 27: Establishing ERM Systems in Emerging Countries

Exhibit 27.1 Patterns of Systemic Banking Crises
Exhibit 27.2 Comparative Review of Risk Management Applications Using COSO Model in Select Emerging Countries

CHAPTER 28: The Rise and Evolution of the Chief Risk Officer: Enterprise Risk Management at Hydro One

Exhibit 28.1 Risk Management Process
Exhibit 28.2 Risk Tolerances
Exhibit 28.3 Probability Rating Scale
Exhibit 28.4 Risk Map
Exhibit 28.5 Corporate Risk Profile
Exhibit 28.6 A Risk-Based Structural Approach to Investment Planning at Hydro One
Exhibit 28.7 Benefits of ERM and Outcomes at Hydro One

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Library of Congress Cataloging-in-Publication Data:

Fraser, John, 1946–

Enterprise risk management : today’s leading research and best practices for tomorrow’s executives / John Fraser, Betty J. Simkins

p. cm. – (The Robert W. Kolb series in finance)

Includes index.

ISBN 978-0-470-49908-5 (cloth)

1. Risk management. I. Simkins, Betty J., 1957– II. Title.

HD61.F74 2010

658.15–dc22

Foreword

I am pleased to welcome this important collection of authoritative papers on enterprise risk management. This subject has, unfortunately, operated below the visibility screen of most CEOs for many years. In the financial institutions, where regulations require a risk management process, most bank CEOs viewed it as a compliance process, much like internal audit and internal controls. They did not view risk management as a strategic process nor one that demanded much of their time and attention. As a consequence, most businesses have limited ability to assess its risk from rapid growth, increased complexity in financing and securitization, and globalization. Company executives have not been the only ones failing to pay sufficient attention to the topic. Few MBA, accounting, or finance programs departments featured courses and training in enterprise risk management.

The events of 2007–2009 have made the gaps in knowledge, training, and attention to risk management abundantly clear, albeit in a highly costly and tragic manner. Businesses, business schools, regulators, and the public are now scrambling to catch up with the emerging field of enterprise risk management. This subject must become a priority for students to study, executives to practice, and regulators to verify. Fraser and Simkins have produced an impressive contribution to the field, one that I believe will help to educate many. I hope this book, beyond its educational and attention-directing mission, will also stimulate the production of other articles and books so that a common body of knowledge can be developed for this vital profession. We are indebted to John Fraser and Betty Simkins for organizing the impressive author team and the editing of this book.

ROBERT S. KAPLAN

Baker Foundation Professor

Harvard University