TCM Guide : The Many Faces Of Risk

Contributed Article: Citigroup

There’s no cutting corners when it comes to managing risk. You’ve established risk committees, appointed risk executivesyou’re looking at it from every angle. To spare your company the potential losses that come with risk exposure, your approach has to start at the top and extend to all facets of your business.

The Association for Financial Professionals (AFP) recently released the findings of its Corporate Treasurers Councils 2006 survey on risk management. The results underscore treasurers expanding roles in their organizationsrisk management efforts. Treasurers responding to the survey indicated that their responsibilities include managing liquidity (90%) as well as managing various types of risk, such as foreign exchange (90%), interest rate (88%), market (68%) and credit risk (64%). The study illustrates corporate treasurers unique role as one of the few functions that can combine risk management process expertise, broad knowledge of the business and working relationships with business units.

Operational risk

Operational risk is the risk of loss resulting from inadequate or failed internal processes, people and systems, or from external events. Operational risk may include the risk of loss resulting from legal and regulatory noncompliance.

ACH applications now support spontaneous transactions, and this new exposure to unknown counterpartiesalong with the generally innovative nature of the payments businesshas led to added levels of risk.

Craig Vaream, U.S. ACH product management, JPMorgan Chase

More than two thirds of the companies surveyed in the 2005 AFP Fraud Survey were targets of fraud in 2005. Just one of the many operational risks companies face, payment fraud has changed the way companies do business. Corporate and business-level teams may help your company focus on compliance and risk issues, but what can you do as a cash manager to help fight fraud and other types of risk?

Education: Training staff at all points in your cash cycle to identify and prevent key risks should be a part of your risk management program.

Targeted solutions: Services from your financial institutions and outside vendors, including check guarantee and positive pay services, can help reduce your risk exposure.

Data security: Store data securely, and perform regular tests of your transaction processing systems and business continuity plans. Take action to protect the integrity and confidentiality of client data and transactions.

Communication: Effective and frequent communication with your customers and thorough knowledge of their practices can help keep all parties informed of potential risks.

When it comes to trade compliance, preventive medicine is better than corrective action.

John Priecko, senior relationship manager, JPMorgan Chase Vastera

Credit risk

Credit risk is the risk of loss due to a counterpartys inability to meet its financial obligations. This includes the risk of nonpayment inherent in transactions with consumers, companies and other counterparties.

Like operational risk, credit risk is an essential element of an organization’s enterprise risk management (ERM) and audit practices. The 2004 Deloitte Global Risk Management Survey found that 84% of surveyed financial institutions include credit risk in their ERM programs. Corporations share similar concerns. Meeting shareholder expectations and complying with regulations requires you to balance risk and return with each account, in all of your lines of business.

Know your limits: For each type of arrangement, know how much exposure your business, and your financial institutions, can accept.

Continuous improvement: Credit analysts should follow a clear set of guidelines to help make decisions, but their input can also help reshape these processes as your business, its customers and the market evolve.

Risk versus reward: The greater the extension of credit, the more creditworthy and/or profitable the customer or relationship should be.

Good crisis management is essential, but never a substitute for daily risk management processes.

Cathy Duffy, Treasury & Securities Services Risk Management, JPMorgan Chase

Systemic risk

Systemic risk is the risk of default or a loss that affects an entire network or system. A loss experienced by one participant or member can affect one or more others, or potentially harm the entire system.

You make good investments and sound business decisions, but even the most informed cash managers face factors beyond their control. Systemic risk may seem intangible, but there are steps you can take to strengthen your business in good times and bad.

Analysts have predicted a 3% rise in global business failures for 2006 (Euler Hermes). Think about the companies with whom you share systemssuch as your banks and service providers. Like you, they all face the uncertainty of the markets and systems that support their businesses. Are they doing due diligence? Have you looked at their finances and assessed their strengths and weaknesses? How would it affect you if one of these businesses or banks fails?

The healthy operation of the ACH Network requires participants to stay informed and take steps to address the parts of the process each controls.

Craig Vaream, U.S. ACH product management, JPMorgan Chase

Awareness: Be aware of the inherent risks and participants in the financial and transaction-based networks and systems in which your organization participates.

Education: Educating your staff and customers about procedures, rules and warning signs helps promote the healthy operation of these networks and systems.

Research: Some statistics and studies on systemic risk are available online from organizations such as the FDIC (bank failures), NACHA (ACH risk) and the European Central Bank (settlement system risk).

Sovereign risk

Sovereign risk is the risk associated with investing and lending funds in foreign countries or overseas banks. These risks can include foreign exchange risk, political risk and the risk of default or other actions by governing bodies, central banks, financial institutions and corporations in these countries.

Some businesspeople say, “How can this be a risk? We all know that China is going to be the manufacturer to the world. We all know that investment dollars are racing into China. So why would we call this a risk?

Larry Christensen, senior relationship manager, JPMorgan Chase Vastera

Your team just put together a deal to enter a new market. What are the risks to your capital, your funds and your staff when you invest or do business in overseas markets? Putting your money and people overseas exposes you to risks you may not have considered when you made the deal or committed the funds. You can face unforeseen political risks or changes to the foreign regulatory environment, or you could have difficulty repatriating profits. How can your organization avoid common pitfalls?

Currencies and accounts: Take measures to reduce the risk in these transactions, including the use of third-party settlement solutions, multicurrency accounts and notional pooling.

Exporting: Know the current regulations and communicate a list of embargoed countries, and take steps to prevent the export of goods and information to these countries.

Politics: Keep up with current events and federal briefings on countries and foreign banks in which your firm maintains interests.

Training: Processes should be in place for IT, R&D;, engineering, manufacturing, sales, order entry, fulfillment, shipping, accounting, legal, the board of directors and compliance to ensure proper measures are taken to control the export of goods, technology and software.

Reputation risk

This type of risk manifests in negative public opinion about a company or its personnel, which may hinder winning new business and keeping existing customers.

Your company’s reputation is an asset beyond measure, and protecting it requires a strong commitment from executives and employees at every level. Your legal and compliance teams work hard every day to keep up with regulations and protect your company’s interests.

Your companys reputation may have taken decades, even centuries, to build. You dont want to find out how easy it is to tear it down.

Eileen Zicchino, chief marketing officer, JPMorgan Chase & Co.

Respondents to a 2004 PricewaterhouseCoopers online survey chose reputation risk as the number one threat to their organizations’ overall market value. For financial institutions and corporations alike, reputation risk is a unique threat. While there’s no question how important a company or brand name is, many companies fail to enact programs to address it with specific measures.

Communication: Reinforce the value of your company’s reputation by communicating openly and proactively about your company’s values, customers, business objectives and standards. Make sure all employees understand the company code of ethics and are held accountable.

Participation: Strengthen your compliance and risk programs by encouraging participation from employees. Notification of suspicious activities, accounts and persons can come from all levels of your organization.

Fiduciary risk

Fiduciary risk is the risk that a fiduciary, such as a trust agent, may fail to perform all of its fiduciary responsibilities, thereby exposing a company to potential monetary loss, reputation loss, legal or regulatory action, and loss of new business.

You can address all of the potential risks within your business, but you also rely on the strength and wisdom of your financial services providers to do their part. The institutions and fund managers in whom you place your trust need to make diligent decisions and take steps to help secure your accounts and investments.

Almost all of our businesses are risk-taking businessesand we spend a great deal of time thinking about all aspects and types of risk inherent in them.

Jamie Dimon, chief executive officer, JPMorgan Chase & Co.

Choice: In a trust relationship, your institutions must hold themselves to a high standard.

Scope: Know the duties you expect of each party in your bank and trust relationships, as well as the liabilities and regulatory requirements.

Research: Study your financial institutions’ investment philosophy, senior leadership style and history of organizational change.

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