Module 4: How to do ERM - internal risk frameworks Flashcards
Define corporate governance
The way the Board CONTROLS the organisation, and the processes it establishes so that it is run by the management in the best interests of the shareholders. Good corporate governance is essential to establishing an effective ERM framework.
3 Main responsibilities of the Board with regard to risk management
- Risk Governance - Setting ERM Policies - Determining Risk Compensation
Outline the responsibilities of line managers with regard to risk management
Responsible to IMPLEMENT the ERM policies agreed by the Board. This involves … setting up suitable risk management processes and … integrating the risk information collected into business decisions. It is essential that line managers understand the risks that they are taking, and are aware of the extent of their risk-taking powers, eg when they can automatically take on a risk, and when they must seek agreement from a more senior decision-maker.
7 Major structural components required for a company to apply ERM to its operations and decision making
- CORPORATE GOVERNANCE - to establish organisational processes and controls 2. LINE MANAGEMENT - to integrate risk management into business processes 3. PORTFOLIO MANAGEMENT - to aggregate risk exposures and identify diversification effects and concentrations of risk 4. RISK TRANSFER - to mitigate excessive risk exposures cost-effectively 5. RISK ANALYTICS - to measure, analyse and report on risks. 6. DATA AND TECHNOLOGY RESOURCES - to support the analytics and reporting 7. STAKEHOLDER MANAGEMENT - to communicate and report on risk.
List the main AIMS OF INTERNAL CONTROLS to which corporate governance codes of conduct refer
- ensuring accurate and adequate RECORD-KEEPING - PREVENTING FRAUD and safeguarding the company’s assets - guaranteeing the accuracy of FINANCIAL STATEMENTS - responding appropriately to risk - ensuring COMPLIANCE with law and any supervisory
Outline the main recommendations of the Cadbury Code of Best Practice which is aimed at improving confidence in financial reports in the UK
- There should be a full Board meeting at regular intervals - The Board should be made aware of many significant activities such as acquisitions, capital projects - Non-executive directors (NEDs) should have key responsibility for certain control and monitoring functions - Shareholders should approve directors’ service contracts in excess of three years - Directors’ remuneration should be subject to review by a remuneration committee made up of NEDs - Company reports should be balanced and understandable
Outline the key features of the UK Corporate Governance Code
- Applies to all UK-listed companies (the Code being annexed to the London Stock Exchange Listing Rules). - Corporate governance is not forced on companies by prescriptive rules. Compliance with this Code is voluntary, although there is a requirement for firms to disclose whether they comply with the Code and, in the case of non-compliance, explain any deviations. - It allows companies freedom to choose a suitable approach given their industry and their size, and to explain any material differences between their approach and the prevailing governance code to shareholders and to the market.
Outline how external risk frameworks influence corporate governance in the USA
A more statutory approach to compliance has been taken through the introduction of legislation in the form of: - Securities and Exchange Commission (SEC) - rules requiring disclosure of Board structure, compensation and role in risk management - the Sarbanes-Oxley Act - requiring independent Board audit committees and at least one “financial expert” - the Dodd-Frank Act - requiring bank Boards to have a risk subcommittee that includes a “risk management expert”
List the 4 Key principles for excellence in corporate governance
- Communication with stakeholders 2. Independence of the Board 3. Board performance 4. Board compensation arrangements
Outline the role of a risk subcommittee of the Board
Accountability for overseeing the management of risks within an organisation rests with the Board, however it may be delegated to a risk management subcommittee of the board. If a risk subcommittee is established, this will be done by drawing up a risk subcommittee charter.
Outline the role of an audit subcommittee of the Board
- to give auditors direct access to the non-executive directors - to ensure the auditors retain their independence from any other business services provided by the audit firm. - emphasises the importance of the audit function to the rest of the business. The role of the audit subcommittee includes: - monitoring the integrity of financial statements. - monitoring and reviewing internal assurance functions such as financial control, risk arrangement and internal audit - recommending, monitoring and reviewing the external auditor.
Key principles for excellence in corporate governance: COMMUNICATION WITH STAKEHOLDERS
The Board has a duty to disclose certain information about the company to stakeholders, which may extend to details of risk management practices. This leads to greater transparency of information for shareholders, and facilitates more informed decision making on their part.
Key principles for excellence in corporate governance: INDEPENDENCE OF THE BOARD
The Board should not be involved in actively managing the company on a daily basis. Rather, it should be distanced from the day-to-day running of the company in order to better oversee and monitor its management.
Key principles for excellence in corporate governance: BOARD PERFORMANCE
The Board should engage in regular, formal self-assessments to rate its performance against any best practice codes it is subject to. This may be carried out at an individual, subcommittee or full Board level. This can be difficult to achieve in an unbiased way, so the use of external consultants may help. There should be regular, independent development reviews and training for new Board appointees.
Key principles for excellence in corporate governance: BOARD COMPENSATION ARRANGEMENTS
Directors should not be overly compensated, however, the compensation should reflect the responsibility and risk of being a director. In order to align director’s interest with those of shareholders, it is important that a reasonable proportion of the compensation should be in the form of company stock. It is also important, for the implementation of ERM, to align directors’ compensation with risk management objectives, eg by linking remuneration to risk-adjusted return.