Chapter 16: Managing Risk in an Organization

1. Chapter 16: Managing Risk in an Organization I think ‘risk manager’ is a misnomer. I don’t manage the risks-it’s up to the businesses to manage the risks. What we’re here to do is to provide assurance that risks are being monitored and managed. Kate Boothroyd Treasury and Risk Management, November 2004, p. 55 An Introduction to Derivatives and Risk Management, 7th ed.

2. Important Concepts in Chapter 16 • The differences between the practice of risk management by end users and by dealers • Principles of effective risk management in an organization • Accounting for derivatives • How some organizations lost money using derivatives • Responsibilities of senior management An Introduction to Derivatives and Risk Management, 7th ed.

3. The Structure of the Risk Management Industry • End Users • Firms that engage in derivatives transactions to manage their risk. • Mostly non-financial corporations, but also pension funds, mutual funds, U.S. state and local governments, foreign governments, endowments, and other private organizations. • In corporations the treasury department is usually responsible for derivatives transactions. An Introduction to Derivatives and Risk Management, 7th ed.

4. The Structure of the Risk Management Industry (continued) • Dealers • Financial institutions that make a market in derivatives. They stand willing to take either side (be a buyer or seller)of a derivatives transaction. • They typically hedge their risk and earn a profit off of the difference between their buying and selling prices. An Introduction to Derivatives and Risk Management, 7th ed.

5. The Structure of the Risk Management Industry (continued) • Other Participants in the Risk Management Industry • consultants, including accounting, management consulting, and personnel search • software firms • law firms An Introduction to Derivatives and Risk Management, 7th ed.

6. Organizing the Risk Management Function in a Company • Good risk management requires a sound organization structure that begins with responsibility at the top. • Dealers usually have an independent risk manager who reports to the CEO, has access to relevant information, and authority to block or initiate certain transactions. • Corporate risk management should also be centralized but is often decentralized. • Many corporations run the treasury as a profit center, which is not conducive to sound risk management. An Introduction to Derivatives and Risk Management, 7th ed.

7. Organizing the Risk Management Function in a Company (continued) • Separation of front office from back office. • Legal counsel, accounting, and auditing are critical, but accounting and auditing do not substitute for risk management. • Risk management is a continuous process requiring regular evaluation and comparison to objectives. • See Figures 16.1, p. 568 and 16.2, p. 569 for examples of typical dealer and corporate end user organization charts. • Under enterprise risk management, the management of all risks is under a single area of responsibility. An Introduction to Derivatives and Risk Management, 7th ed.

8. Avoiding Derivatives Losses • See Table 16.1 partial list of organizations reporting derivatives losses. • Four case studies: • Metallgesellschaft: To Hedge or Not to Hedge? • Orange County, California: Playing the Odds • Barings PLC: How One Man Blew up a Bank • Proctor & Gamble: Going Up in Suds An Introduction to Derivatives and Risk Management, 7th ed.

9. Risk Management Industry Standards • Two organizations have established standards for the practice of risk management: • Group of 30 (G-30). See Table 16.2 • Risk Standards Working Group. See Table 16.3 An Introduction to Derivatives and Risk Management, 7th ed.

10. Responsibilities of Senior Management • Senior management is ultimately responsible for all organizational activities. With respect to risk management, these responsibilities can be summarized as: • Establish written policies • Define roles and responsibilities • Identify acceptable strategies • Ensure that personnel are qualified • Ensure that control systems are in place An Introduction to Derivatives and Risk Management, 7th ed.

11. Summary An Introduction to Derivatives and Risk Management, 7th ed.

12. (Return to text slide) An Introduction to Derivatives and Risk Management, 7th ed.

13. (Return to text slide) An Introduction to Derivatives and Risk Management, 7th ed.

14. (To Continue) (Return to text slide 21) An Introduction to Derivatives and Risk Management, 7th ed.

15. (To previous slide) (Return to text slide 21) An Introduction to Derivatives and Risk Management, 7th ed.

16. (To Continue) (Return to text slide 22) An Introduction to Derivatives and Risk Management, 7th ed.

17. (To Continue) (To previous slide) (Return to text slide 22) An Introduction to Derivatives and Risk Management, 7th ed.

18. (To previous slide) (Return to text slide 22) An Introduction to Derivatives and Risk Management, 7th ed.

19. (To Continue) (Return to text slide 22) An Introduction to Derivatives and Risk Management, 7th ed.

20. (To previous slide) (Return to text slide 22) An Introduction to Derivatives and Risk Management, 7th ed.