Assessing ERM Practices

ERM Working GroupNorth Carolina State University

Raleigh, February 24th 2006

Copyright © 2005 Standard & Poor's, a division of The McGraw-Hill Companies. All Rights Reserved.

Prodyot Samanta Ph.D., Director ERM

Agenda

What do firms mean when they talk about ERM?

Standard and Poor’s approach to assessing ERM practices

ERM criteria applied to Trading Risk

Discussion/Q&A

304/20/23

What is ERM?

Several definitions with common themes

Integrated, firm-wide approach for understanding, managing and communicating risk

Cuts across business units, geography and risk types

Delivers a better understanding of the risk/reward trade-off

Aligns strategy with firm’s risk appetite

Different approaches to implementation:

For some, ERM is a qualitative approach to identifying, measuring and managing risks in a consistent, integrated way

For others, the focus of ERM is quantifying and aggregating risk types (e.g. economic capital modelling)

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Enterprise Risk Management:A Holistic View

ERM

Risk

Transfer

Risk ratings admin control

PortfolioManagement

Frau

d

Trading

Sales

Practice

Rep

utat

ion

Conflict o

f

Inter

ests

Management

IncentivesProduct Innovation

Competition

Disclosure

Risk

Appetite

InvestingStructuring

Underwriting

Acc

oun

tin

g

Fidu

ciar

yPro

cessi

ng

Clearin

g

Credit

Market

AL

M

Com

plia

nce/

Leg

al

Strategic/Business

Policies

Aud

itO

pera

tiona

l

Risks within the enterprise are inter-related and cannot be viewed in isolation

Risk integration and aggregation is enabled through-out the enterprise via a common data architecture and a single valuation engine

Corporate governance is the glue that binds this into a consistent and coherent structure

Institutions will have a unified framework for measuring and managing risks

What is Standard and Poor’s approach to assessing ERM practices?

604/20/23

The PIM Approach for assessing ERM practices

PO

LIC

IES

INFRASTRUCTURE

METHODOLOGY

OPERATIONS

GO

VE

RN

AN

CE

&R

ISK

CU

LT

UR

E

RIS

K A

PP

ET

ITE

&

ST

RA

TE

GY

RIS

K C

ON

TR

OL

RIS

K D

ISC

LO

SU

RE

RISK ARCHITECTURE

VALUATION

TECHNIQUES

MODEL V

ETTING &

BACK-TESTIN

G

ERM criteria applied to assessing trading risk management practices at financial institutions

804/20/23

Implementing PIM to Assessing TRM Practices (1)

PIM – Policy & Governance:

How is the stature of the risk management function evaluated and how important is this in the aggregate assessment?

Independence of the risk function Partnership and strategic role with the business CRO reporting to the CEO

In assessing the process by which an institution establishes its risk tolerance, what criteria is applied?

Process for establishing the risk tolerance (qualitative and quantitative) that consider tactical and strategic objectives

Quality of the process for approving new products (NPA committees, clear definitions, documentation, tracking, follow-up)

904/20/23

Implementing PIM to Assessing TRM Practices (2)

PIM – Policy & Governance:

Is it Standard & Poor’s goal to lead financial institutions to disclose more than required by the SEC? What criteria is applied with respect to disclosure?

No! (That is not the intent) However, good practice would be where institutions took a leadership

role and articulated the relevant risks to their shareholders that go beyond what is dictated by regulation

Assess the quality of both internal and external disclosure Internal reports to senior management should should summarize

financial and non-financial risk

1004/20/23

Implementing PIM to Assessing TRM Practices (3)

PIM – Infrastructure & Methodology:

What is evaluated in terms of Risk Technology and Back Office operations?

Should be independent of the Business Should track KRIs Quality and level of systems integration

How important is VaR as a risk measure in Standard and Poor’s criteria for assessing the trading risk management practices of an institution?

Unfortunately not much! Stress Testing and “What-If” scenario analysis is important And other measures beyond regulation

1104/20/23

Ok, What’s The Impact On Ratings?

If an institution falls short of, or exceeds, expectations, would it warrant a downgrade or an upgrade? Have there been any such rating actions?

If there are any material weaknesses or significant strengths, it could impact rating!

1204/20/23

Q&A?

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