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Finance:  Ineffective risk management impacts credit rating


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Ineffective risk management impacts credit rating

Against a backdrop of turbulent financial markets, cuts in credit ratings and the high-profile losses, regulators have been placing more focus and reliance on risk management.  This is reflective of the increasing need for greater management of principal risks and robust internal control.

Investors are also increasing the weight attached to an organisation’s risk management performance, and rating agencies too, have recently enhanced their rating assessments to place more emphasis on risk management.

One of those rating agencies is Standard & Poor’s (S&P), who, in 2005, in the wake of Hurricane Katrina, started incorporating ERM discussions in rating financial institutions and insurance companies.  S&P found a correlation between strong ERM practices and a company’s ability to respond quickly to risk.  S&P recently announced that they will enhance their credit rating evaluation to include a review of risk management practices for companies outside of the financial services sector, a move that Steven Dreyer, managing director of Corporate Ratings, says will “ultimately enhance transparency by providing investors and issuers our views of a management team’s ability to understand, articulate and successfully manage risk.”

Enterprise Risk Management is an organisation’s competency to manage uncertainty, thereby more effectively minimising threats and maximising opportunities.  Companies that better understand and anticipate what can go wrong have an improved opportunity to effectively manage their risk.  Better management of risk by Gauteng businesses and organisations can lead to more certainty around the achievement of business objectives, which in turn can lead to increased value for the organisation's stakeholders.

It is important for companies to define their key business risks on an enterprise-wide basis.  They must prioritise those risks in relation to their overall objectives and define actions to improve and monitor those risks.  It is equally important to bring all activities of a company together within a broader business risk framework to reap the full value of individual initiatives.

However, the value of effective risk management is often difficult to quantify in monetary terms and often the level of effectiveness of risk management in organisations is questionable.  S&P states that there is no single recipe for the best ERM platform, and believes they can distinguish each company’s effectiveness in managing risk by relying on a customised and consistent framework.  The focus of S&P will initially be on the risk management culture and strategic risk management. Communication of risk and risk management inside and outside the company are important indicators of the risk-management culture and a company with a strong risk culture will have a very transparent risk management process.  The process the company uses to incorporate the ideas of risk, risk management, and the return for risk into corporate strategic decision making is also considered.

Credit rating agencies provide an opinion of an obligator’s ability and willingness to pay a financial obligation in time, and in full, and in accordance to its terms.  In order to avoid being down rated, and cost of credit increasing, it is now essential for organisations to demonstrate how risk management is embedded into the day to day operations.

Article by Lisa Jonker, Director, Business Risk Services at Ernst & Young, Gauteng.

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