World Bank Risk Management Seminar

1. World Bank Risk Management Seminar Enterprise Risk Management May 19, 2004 James Lam President ph: 781.772.1961 jameslam@comcast.net

2. Enterprise risk management should be defined as a value added function Definition of ERM: “An integrated framework for managing credit risk, market risk, operational risk, economic capital, and risk transfer in order to maximize firm value.”

3. Financial Risks Credit Risk Associated with Investments FX risk in a new foreign market MarketRisk Asset Liquidity CreditRisk LiquidityRisk Credit Risk Associated with Borrowers and Counterparties Derivatives documentation and counterparty risk Funding Liquidity Technology and operations outsourcing ERM is useful because the risks faced by companies are highly interdependent Enterprise-Wide Risks FinancialRisk Business Risk OperationalRisk

4. Enron • WorldCom • Adelphia • Mutual Funds Corporate Disasters • Banks • Asset Managers • Energy Firms • Corporations Best Practices RegulatoryActions • S.E.C. • Sarbanes-Oxley • Basel II • Treadway Report, US • Turnbull Report, UK • Dey Report, Canada IndustryInitiatives The growing acceptance of ERM is driven by four key forces EnterpriseRiskManagement

5. While regulatory mandates are useful, don’t let the tail wag the dog Proactive Approach Reactive Approach Currentstate CEO ? ? ? • Benchmarking • Gap analysis • Recommendations ? ? Desired state (best practices or best-in-class practices) Sarbanes- Oxley Basel II • Common themes • Unique standards New industry standards Sarbanes- Oxley New industry standards Basel II Governance Requirements Governance Requirements

6. 5/00 “This decade's hot executive is shaping up to be the CRO.” 7/7/00 “Once it sold its own power…today Duke [Energy] is a major trader and marketer… Hence Duke’s naming of a chief risk officer.” “As interest in enterprise risk management grows, so does the acceptance of the role of chief risk officers to manage such programs.” 5/00 Over the past decade, CROs have gained acceptance and prominence Risk Magazine 3/99 “Not so long ago, risk managers were second-class citizens…that was before LTCM …The result has been the rise of a powerful new breed of risk manager.” 3/00 “The chief risk officer has come to all kinds of companies.”

7. 1. Corporate Governance Establish top-down risk management 3. Portfolio Management 4. Risk Transfer 2. Line Management Transfer out concentrated or inefficient risks Business strategy alignment Think and act like a “fund manager” 6. Data and Technology Resources 5. Risk Analytics Develop advanced analytical tools Integrate data and system capabilities 7. Stakeholders Management Improve risk transparency for key stakeholders An ERM framework should encompass seven key building blocks

8. CROs must overcome significant barriers to success • Inertia – absence of crisis; general resistance to change • Lack of management sponsorship or line support • Episodic initiatives with no long-term vision • Ineffective and inconsistent risk metrics and reporting • Insufficient human, systems, and data resources • Failure to clearly demonstrate “early wins” and sustainable benefits • Move too fast or too slow, without addressing change management issues

9. Background 3-Year ERM Program • $1 trillion of assets under management • Private company • Decentralized business culture • Organized Global Risk Forum • Implemented annual Global Risk Review • Automated loss accounting • Developed ERM framework • Implemented intranet-based Global Risk MIS • Experienced significant reduction in loss ratio Case study:

10. Early adopters of ERM have reported significant and tangible benefits

11. Ten predictions on the future of enterprise risk management • ERM will become the industry standard • CROs prevalent in risk-intensive companies • Audit committees will evolve into risk committees • Economic capital in; VaR out • Risk transfer executed at enterprise level • Advanced technologies key to advancement • A measurement standard will emerge for operational risk • Risk-based or economic reporting becomes standard • Risk becomes part of corporate and college programs • Salary gap among risk professionals continues to widen