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Enterprise Risk Management at

John R.S. FraserVice President, Internal Audit& Chief Risk Officer, Hydro One Inc.

February 15, 2006for PRMIA Toronto Chapter - The Fields Institute

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Summary 1. Background on Hydro One

2. Motivations and Commitment3. Developing an Approach

4. Challenges

5. Our ERM Processa. Risk Tolerances

b. Risk Profilec. Resource Allocation

6. Future Phases and Benefits

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Background on Hydro One 1

Background on Hydro One Ontarios primary

electricity transmission &distribution company One of the largest Tx

companies in N.A. $11 B of assets $4 B of annual revenue $1 B annual capital and

maintenance spend 4,000 employees

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Motivations and Commitment 2

Notice - What ERM is not about

Sarbanes-Oxley/Bill 198

Compliance

Audits

Regulations

Performance Measurement

Credit/Market or Operations Risk

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Notice - What ERM is about Good Governance

Good Management

Agreed objectives and risk strategies

Future Outlook

Prioritization of objectives and risks and mitigants

Resource allocation based on risks

No surprises

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Motivations - Is there a need in your organization? Degree of change in the

organization and/or theindustry

Degree of change in seniormanagement

Appetite for:

governance (actual andoptics)

clarity of decision making

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Drivers for ERM Intellectual thinking (see readings at end)

Corporate Governance (led by Cadbury, Dey and COSO in mid-1990s)

Scandals, surprises and reactions:

Barings Bank Sarbanes Oxley Rating Agencies

Director Colleges Recent Media Attention

Professional Associations (actuaries, insurance, IIA)

3Motivations and Commitment

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Risks Identification

! " #!!$

4Motivations and Commitment

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6

2000 - The Changing ElectricityMarketplace

Unprecedented change withinthe industry (re-regulation,commercialization, reorganizations)

Ontario Hydro broken up in 1999 Debt no longer guaranteed

Aging workforce and different skillneeds

For 2002: IPO and Market Opening

Motivations and Commitment

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Developing an Approach 9

History of ERM at Hydro One Previous attempts with highly visible use

of consultants ERM in Strategic Planning Group

Organizational realignment with CFO in 1999

New staff brought in to ERM Group

Can the Head of Internal Audit be the CRO?

January 2000 - New Beginnings

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Risk Management at Hydro One (Aug 2000)

Process Sophistication

V a l u e

RiskSpecialization

EnterpriseRisk Awareness

Risk ManagementIntegration

Risk/MitigationOptimization

6 months 12 months 18-24 months 24-48 months

Senior Managementand Board of Directorsinformation needsevaluated;

Preliminary risk profiledeveloped;

Policies established orrefined;

Standard terminology,techniques, documentsestablished;

Functional unitaccountabilitiesclarified

Risk Profile refined(focus is on residual risksand tolerances);

Regular reporting toSenior Managementand Board ofDirectors established;

Corporate risk assessmentembedded in businessplanning process;

Local risk ownersidentified; local risk

management expertiseidentified; skills andknowledge transferoccurring

Corporate performancemeasures refined torecognize risk tolerancesand priorities;

Risk assessment andprioritizationfully embeddedin business planning;

Risk profileinterdependenciesrecognized;

Local risk management

processes fully active

Clear ties betweenstakeholder value andrisk management activities;

Comprehensive risk portfolio created; newrisk exposures identifiedearly; appropriate priority andmitigation determinedquickly;

Risk management embeddedall key business processes,including strategic planning;

Local risk managementprocesses fully aligned withCorporate objectives

Complete Partially Complete

Developing an approach 10

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11

ERM at Hydro One ERM Policy:

ERM provides uniform processes to identify, measure,treat and report on key risks

This is the umbrella policy under which all other risk policiesfall

Key principles: includes portfolios of ALL types of risks,integrated with strategic and business planning, annual riskassessments

Key accountabilities: Audit & Finance Committee, the

President, CFO, Management and CRO

ERM Framework: Establishes the basic process for all risk assessments

Developing an Approach

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BOARDCOMMITTEE

EXECUTIVEMANAGEMENT

LINEMANAGEMENT

CORPORATERISK

PROFILEPOLICY &

FRAMEWORK

AUDITED

BYINTERNAL

AUDITRISK

PROFILES

RISKTOLERANCES

MANAGERISKS, $$

The ERM Process at Hydro One

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Challenges 12

Challenges New definitions

Magnitude (largest credible risk) Controls (when executives are involved) Risk Trends

Agreeing Risk Tolerances with executivesand board

Staffing (showman and analyst)

Software selection (Delphi, Roll-Up)

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Risk Tolerances

BusinessObjectives

Event ImpactDescription

5Worst Case 4Severe 3Major 2Moderate 1Minor

EarningsVolatility

Net Income shortfallafter tax, in the sixmonths leading up tothe IPO

$ 75 M shortfall $ 35 M shortfall $ 15 M shortfall $ 8 M shortfall $ 4 M shortfall

Brand(Reputation )

Negative Mediaattention, Publiccriticism (from anycause; could includereliability, legalcompliance,environmental, safety)

International MediaAttention, Complete lossof confidence/major publicembarrassment; opinionleaders / customers nearlyunanimous in publiccriticism

National MediaAttention; Extensiveloss of confidence/ public embarrassment;most opinion leaders/ customers publiclycritical

Provincial Profile;Material erosion inconfidence;several opinionleaders/customerspublicly critical

Local Profile;Confidence inquestion; seniormanagementinvolvement inresponding tospecific issues

Letter to Govt. orSenior Management;Localized criticism;correspondence ormanagementmeetings required toclarify position

Align

Workforce withBusinessNeeds

Employee perceptionsnegatively affected Sharp Deterioration inEmployee Survey Results

Modest Decline inEmployee SurveyResults

No Improvement inEmployee SurveyResults

Much Less-than-plannedImprovement inEmployee SurveyResults

Less-than-planned

Improvement inEmployee SurveyResults

IncreaseWorkforceSafety

Employee Injuries >50%- 100% above target;employee fatality

25%-50% above target;major permanentdisability

15% -25% abovetarget

Less than 15%above target No Improvement

Worst Case:

- threatens thesurvival of

Hydro One Inc.in its current form

Major:

- significantdeterioration

in results

Minor:

- noticeabledeterioration

in results

17Our ERM Process - Risk Tolerances

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Structured Risk Interviews

HumanResources

Retaining

ExpertiseTrainingLabour

Agreements

Commercial

Culture

Volatile Work

Schedule

18

BudgetSkills

Our ERM Process - Risk Profile

DemographicsCompetition

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Risk Source March 2001 Dec. 2001 Risk Trend

Cost Reduction Very High Very High

Regulatory Uncertainty High Very High

Initial Public Offering High High

Customer Relationships High Medium

Human Resources Medium Medium

Safety High Medium

Corporate Risk Profile

Note: Each risk category is explained witha half page analysis outlining the sources ofthe risk and the mitigants in place or planned.

20Our ERM Process - Risk Profile

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True tolerances: Red Zone

5 W o r s t C a s e

4 S e v e r e

3 M a j o r

2 M o d e r a t e

1 M i n o r

5 Very Likely

4 Likely

3 Middle Odds

2 Unlikely

1 Remote

Our ERM Process - Resource 21

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Basic Process

Carve work into packages

Define alternative investment levels

Estimate the incremental cost at each level

Evaluate residual risk at each level

Rank based on value for $, cut-off

22Our ERM Process - Resource

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Program Level Cost Cuml.Cost Risk if notdone Bank forBuck(1)

Tree Trim Hi hest Risk $2 $2 4.6Lines Hi hest Risk $6 $8 4.5Poles Hi hest Risk $1 $9 3.9Tree Trim Minimum Level $1 $10 2.8 2.80Lines Level 1 $3 $13 3.0 1.00Tree Trim Level 1 $2 $15 1.9 0.95

Lines Minimum Level $5 $20 3.2 0.64Poles Minimum Level $12 $32 2.3 0.19

Ranking across work programs

(1) value for $s

IntolerableRisk

BANG

forBUCK

Resources =$14

823Our ERM Process - Resource

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Framework Initiated Formulated Implemented Robust

ERM Policy

ERM Framework

Executive Risk Committee

Common Language

Dedicated Corporate Risk Group

Champions

Integration with loss control

Integration with Strategic Planning

Integration with Business Planning

Hydro One ERM Status - April 2002

24Future Phases

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Tools & Techniques Initiated Formulated Implemented Robust

Approved Risk Tolerances

Workshops - Line

Workshops - Leadership

Voting Software

Measurement broad rangesMeasurement detailed metrics

Risk Register NAM only NAM only

Business Plan Templates

Scenario analysisSign-off by Line Management NAM only NAM only NAM only

ERM in VPs Personal Contracts


25Future Phases

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Deliverables Initiated Formulated Implemented Robust

Corporate Risk Profile

Reporting to Leadership Team

Reporting to Audit & FinanceCommitteeReporting to Board


26Future Phases

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Benefits of ERM Rating Agencies are now looking for it, so direct

bottom line impact

Improve communication between board andmanagement

Reassures stakeholders that the business is wellmanaged

Helps meet international risk management standard,

such as AS/NZS 4360 & COSO (2004) Allocate resources based on risk priorities

Avoid surprises and help ensure stability2027Benefits

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Staying in Business

% & ' ( )##

& * + ! " # $ , - . / ( )$0

28

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Foundational Readings Vernon Grose Managing Risk: Systematic Loss Prevention for Executives (1986)H. Felix Kloman and Seawack Press Inc. publish monthly the Risk Management Reports

Standards Australia

Risk Management - AS/NZS 4360 (1995, 1999 and 2004)Organizational experiences in implementing risk management practices (Feb 2002)

The Conference Board of Canada:

A conceptual framework for integrated risk management (1997)

How integrated risk management can benefit your organization (1998)

Enterprise Risk Management - Inside and Out (2005)

James W. DeLoach

Enterprise Risk Management - Strategies for linking risk and opportunity (2000)

Canadian Institute of Chartered Accountants 20 Questions Directors Should Ask About Risk (2003)

Tom Aabo, John Fraser & Betty Simkins The Rise and Evolution of the Chief Risk Officer:Enterprise Risk Management at Hydro One (2005) Morgan Stanleys: Journal of Applied

Corporate Finance29

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Questions?

hydro one

Documents