Risk management is surely a critical area for corporates and investors. With the touch points of risk gaining new dimensions, the concern for investors grows. In this matter, investors need to analyse risk and how can corporate India manage these effectively. Suresh Parthasarathy, Director of Zylog Systems, spoke with Abhay Rao of The Financial Express about risk management in India, its importance to the corporate sector and how can this niche field help in the years to come. Excerpts?
•Which aspects of corporate risk management do you feel are the most crucial at this point of time?
Every entity, whether for-profit or not, exists to realize value for its stakeholders.
Value is created, preserved, or eroded by management decisions in all activities, from setting strategy to operating the enterprise day-to-day. ERM supports value creation by enabling management to:
Deal effectively with potential future events that create uncertainty.
Respond in a manner that reduces the likelihood of downside outcomes and increases the upside.
What investors need to know is that Indian corporate houses need to develop a robust enterprise risk management framework. Enterprise Risk Management (ERM) is a way of thinking, measuring, and managing that enables managers to maximize the value of their firms to shareholders. ERM can help managers increase shareholder value by quantifying what is otherwise invisible to them. Managers manage only what they can see and quantify. Typically they see and quantify only accounting values: current surplus.
We feel the current issues in risk management are:
•Proliferation of structured derivative products that are pushed as risk management tools, but in fact lead to mounting losses to the firms.
•Development of a robust risk management framework
•Develop measures of sensitivity of cash flows to various scenarios
•Identify the top ten macro factors that will affect the profitability of their firms
•Increased Focus on Risk Appetite and Optimizing Risk versus Return
•What common mistakes do you feel companies in India are making when it comes to risk management? What should they be ideally doing?
Indian companies have been doing business for quite a long time. Hence they have the foundations of risk management in place. No firm can survive for long if the management is not tuned in to risk management. What Indian firms lack is an introduction to the quantitative aspects of risk management, the emerging methodologies of measuring risk, and know how on the currently available tools to hedge risks.
Quite a few Indian corporates have a risk register where they write up individual risk events. Once the risk is registered, the employee feels he/she has done their duty. It is for the risk managers to take it up. This ensures that the risk events are identified but not followed up on. This is a big issue.
Indian firms have not yet adopted modern risk management practices. Very few firms have a chief risk officer. An even fewer will have the CRO report directly to the board. Risk is an added responsibility of either the internal auditor or the CFO. Both these options are not right. Risk Management needs a full time Chief Risk Officer who is trained in all aspects of risk management. Another aspect that is of concern is the lack of investments in the tools and technology to manage risks. Indian corporate houses lag their peers in other countries in this regard.
We feel Indian firms need to adopt the following:
•Adopt an enterprise wide risk framework.
•Train every individual in the organization to identify risks and if nothing else report it to the appropriate authorities.
•Instill risk awareness across the organization and encourage best practices
•Provide an objective framework to consistently measure and aggregate risk across operating units
•Identify significant risks and report on emerging risk issues
•Facilitate group-wide discussions of industry issues
•Empower the rank and file to come up with responses to risk events.
•How big do you feel is the risk management service providing business in India as of now?
As on date the risk management services sector is just taking off. Only the top few corporate houses have a full fledged enterprise risk framework in place. Currently the risk management service is restricted to consulting services and software tools. We see this business growing exponentially in the near future. Apart from consulting services, we see risk audits gaining ground. Other areas will be services like model validation, model calibration and model tweaking to gain currency.
•How is the risk management industry doing and how do you feel its future is currently looking?
The risk management practitioners in India have a long road to cover. There is very little empirical research in India. Models are being pushed with little thought. On the other hand we are getting into the most exotic of structured products, with very rudimentary awareness of the risks associated with them.
Another issue is that consultants and vendors tend to push the one model they have as the answer to all risk management issues. We feel that as true risk professionals, we need to be model agnostic ? we should not fall in love with any one model. We need to accept that all models are wrong. But some may prove useful if used correctly.
The risk management industry is poised for a quantum leap. Increasing integration of Indian economy with the global economy has opened up new avenues for Indian firms. At the same time they are now more open to a wider array of risks. As late as 1997, India escaped the Asian Financial Meltdown. Cut to 2008, Indian economy has been affected by the current financial crisis.
Ten years from now, we may be hit harder than we would like to.
This awareness will propel firms to invest more in risk management services and systems. As we integrate into the global economy, our risk management tools and responses will need to be best in class. We need systems that will enable us to identify and track the emerging risk matrix around us. Our responses will need to be calibrated and quick.
•How is the current awareness level of risk management as an issue amongst companies and individuals? Should investors also be aware of risk management as a threat or benefit to a company? Have you seen this play a role in a companies backing ever?
We should realize that our firms have been prospering for a long time. This sometimes leads to a mistaken assumption that we do not need better risk management systems ? a belief that what happens in other countries will not happen here. This is a big problem in India.
However, the board and senior management of Indian firma are being made aware of the benefits of a robust ERM. However, what is lacking is an awareness of how to go about developing ERM. Unlike other consulting assignments, risk consultants need to be aware of the business of the firm, the operating processes, the culture of the firm, the legal and statutory frameworks apart from specialized knowledge of the process of risk management. This is an issue for firms in India.
Among the rank and file of employees, there is an increasing emphasis of risk awareness. However, we are of the opinion that there is a dearth of qualified risk professionals in the country. Awareness is just the beginning. The more serious issue is that of doing something about it. The employees need to be trained to identify measure and mitigate risk as it happens. Not as a post facto action to be taken by a few individuals.
There is a serious lack of risk education in India. We do not have any MBA college offering a post graduation in Risk Management. Hence there is a lack of qualified risk professionals in India.
As investors, we need to be aware of the risk management practices of the firms we are investing in. As we have said earlier, a firm with robust ERM is more likely to grow in spite of tough economic conditions. A time is not far off when investors will be willing to pay a risk premium for safer firms.
This is not yet seen among the corporate sector. However, in the current scenario, this is happening among financial firms. Banks have to necessarily disclose their risk management practices as a part of the Basel II disclosures. It has been observed that banks that do not comply with the Basel II regulations are finding it difficult to get favorable lines from other banks. This practice will gather momentum going forward.