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Shandong Foreign Trade Administration Bureau

Workshop about Enterprise Risk Management
(ERM)

Jinan, May 26 th 2009
by
Wolf-Bernhard KERSTEN
Professor of Economics
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Agenda: Chapters
1. Introduction
2. Global Financial Crises, World Wide Recession and the Impacts on
China
3. The ERM: Concept + Theory
4. The ERM: Implementation Procedures
5. The ERM: Implementation in China
6. Q + A
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Chapter 1: Introduction
1.1 About the lecturer
1.2 Target of this work shop
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1.1. About the lecturer: summary CV (1)
Education
< Banker
< graduated School of Economics, German Nr. 1 University
< Associate Professor
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1.1. About the lecturer: summary CV (2)

Business career: global nr. 1 Credit Insurer
< Sales Area Manager
< Director Sales Regional
< Director Sales Domestic Bank-Assurance
< Head of Bank-Assurance
< MD of Group Collection Company
< Member of the Executive Management (15 years)
< CSO Asia Pacific (8 years)
< CEO, Chairman, President in 10 Asian countries
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1.1. About the lecturer: summary CV (3)
Academic Career: Professor at various Universities
< since 2002: Hamburg, School of Economics, MBA
< Tianjin, Nankai University, School of Economics
< Beijing TBU, School of Finance+ Trade
< Shanghai, East China UST, MBA
< Shanghai, IBFI, MBA
< Shanghai, CEIBS, MBA (EU-China Program)
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1.1. About the lecturer: summary CV (4)

Advisor / Consultant: in total 12, for e.g.
< leading Credit Insurers in China
< Re Insurers
< Banks
< Central -, Provincial - + Municipality Governments
< Economic Development Zones
< Chinese - + Western Enterprises
< COO Olympics, Beijing 2008, German Hockey Association
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1.1. About the lecturer: summary CV (5) 1.1. About the lecturer: summary CV (5)

Majors:
< Strategic Management
< Marketing + Sales
< Finance + Funding
< ERM
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1.1. About the lecturer: summary CV (6)

Assets, Strengths
< International (over 100 countries globally)
< bi - lingual (German-English)
< plus 3 more languages
< in China living since 2001
< wide + deep guanxi
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1.2. Target of this Work Shop
< to support Shandong Government
< to help to implement ERM into local enterprises
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Chapter 2: The Global Financial Crises, the
World-wide Recession and the Impacts on China

2.1 Summary Report to the Central Government: highlights
2.2 Actions, China should do now
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2.1. Summary Report: highlights (1)

< Start of the Financial Crises
< Historical, political, social + economical history
< Global Interdependency of Risks Spread
< Impact on world-wide Recession
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2.1. Summary Report: highlights (2)

< 3 rd generation of financing products
(CDS, STS gambling character)
< Normative failures
(Greed, Rating Agencies, Supervisory Authorities )
< Wrong capitalism theory approach
< 98 % of all bankers + Governmental Officials: no clue
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2.1. Summary report: highlights (3)

< Recession started end of 2007, but
< Prices increased (commodities, interests )
< Credits became delinquent (private, commercial)
< ABS/MBS CP became toxic
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2.1. Summary report: highlights (4)

< Inter - Banking cash system collapsed
< First Banks collapsed (UK, US)
< Cash deficit in the production market
< Mistrust against Banks + Government
< Insolvency ratio increased
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2.1. Summary report: highlights (5)

< Macro economical dependencies
< Im and Export
< Saving and consumption
< Bubble global economy
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2.1. Summary report: highlights (6)
< Banks and Insurers collapsed (UK, US)
< Mio of employees lost jobs
< GDP: Germany: minus 5 %, Japan: minus 4 %
< Tiger States: all minus GDP
< biggest recession since 1929
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2.1. Summary report: highlights (7)

< Governments had to react (G 20)
< now all major banks and insurers in the West belong to
the Government (similar to China)
< the consequences will last for the next years
< the printing of fresh money will lead to a hyper inflation
< the US household shows a deficit spending which will impact
the US policy for the next 20 - 30 years
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2.1. Summary report: highlights (8)
< Consequences for China:
< Economic down-turn
< Export ratio down since 6 months with minus 20 %
< in 2009: 15.000 companies closed in South of China
< 70.000 toy factories closed
< 40 mio workers lost jobs
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2.1. Summary report: highlights (9)

< Consequences for China:
< GDP 2009: increase with + 5 % ? (IFC, Worldbank)
< GDP 2010: increase with + 6 % ?
< break - even GDP: + 8 %, otherwise
< but: financial stability, huge currency reserves
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2.1. Summary report: highlights (10)

< Consequences for China:
< Dependency on world trade huge
< Dependency on USD huge (depreciation risk)
< China acts de facto as Bank for America
< Unemployment rate will increase (social instability)
< University graduates no chance for jobs
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2.2. Actions China should do now:
in total 28 (1)

< Macro economical and fiscal
< Social welfare (health, pension)
< Stimulation package too late + too small ?
< Central regulation + planning possible ?
< Corruption problem unsolved
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2.2. Actions China should do now:
in total 28 (2)
< Domestic demand increase possible ?
< Infrastructure projects take too long ?
< Environment problems will increase tax burden
< Education programs more professional + faster
< Micro lending systems underdeveloped
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Chapter 3: The ERM Concept + Theory
3.1 The Basics of ERM
3.2 The Advantages
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3.1. The Basics of ERM (1)

< ERM regards the company as a human being
< ERM follows the thinking of the TCM
< body, soul, brain, heart all is interdependent
< it is a mathematical matrix approach
< it helps to steer the complex business reality
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3.1. The Basics of ERM (2)
< it forces all levels in a company to permanently reconsider,
that all actions will have an impact on many other levels
and functions (chain reaction)
< it is an integrated, interdependent approach
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3.1. The Basics of ERM (3)

< however it is not easy to implement
< it takes about 3 years in reality
< it needs much training work
< but: it is the best Management Strategy to date
< it has been approved by the FORTUNE 500
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3.1. The Basics of ERM (4)
< the key elements are:
< we regard all functions from the risk perspective
< whatever we do, it is risky
< but risks are now a chance and not a threat
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3.1. The Basics of ERM (5)
< it defines all risks in the work flow chain
< it measures all risks in quantitative figures
< risks which cannot measured must be deleted
< only business which brings profit will be conducted
< it is based on a clear Strategic Management Approach
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3.1. The Basics of ERM (6)
< it permanently allocates the resources of the company
< are we doing the right things and if so:
are we doing them right?
< first step is a qualitative SWOT analysis
< the two key elements are: how do we handle mistakes
and what is our USP ?
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3.1. The Basics of ERM (7)
< it needs clear objectives which are measurable
< it needs a controlling tool
< it needs handbooks, guidelines, job descriptions etc
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3.1. The Basics of ERM (8)

< what is a risk?
< it is the uncertainty of outcomes and the likelihood
of an impact on the objectives of a company
< it asks for the risk price
< it asks for avoiding, mitigating or transferring of risks
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3.2. The Advantages of ERM (1)
< ERM driven enterprises are 25 % more intelligent than others
< the knowledge level of each staff increases permanently
< 80 % of all functions now become measurable
< decisions can be based much more on facts and not on feelings
< the company acts professional
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3.2. The Advantages of ERM (2)

< the staff is more happy (happiness leads to more success)
< the efficiency ratio increases y-o-y with 50 to 70 %
< the intangible assets can be bundled (EDP system)
< the profit and the market share increase (rating)
< the insolvency risk for the own company decreases
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Chapter 4: The Implementation of ERM
4.1 The Strategic Management Approach
4.2 The Treatment of Risks and Risks Components
4.3 The 12 Major Types of Risks in detail and its interdependencies
4.4 The Experience in the West about ERM
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4.1 The Strategic Management Approach
(1)

< starts with a vision statement: where do we want to go ?
< defines the long term target of a company
< e.g.: we want to become nr. 1 in our niche market
< follows a cycle approach: from top to down and back
< every department defines its own vision, following the group vision
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4.1. The Strategic Management Approach
(2)

< followed by the mission statement:
how do we want to reach our long term goal?
< defines the allocation of resources within the group
< resources: human capital, finance capital, fixed assets,
intangible assets
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4.1. The Strategic Management Approach
(3)

< every department now decides about their respective objectives
< the Top Management checks and revises
< objectives are always measurable:
department x will increase its market share on market A with 13 %
< or: production costs of product III will be decreased with 20 %.
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4.1. The Strategic Management Approach
(4)

< every employee gets its own objectives
< this needs a clear job description
< plus: guidelines, handbooks, communication and reporting rules,
manuals etc
< plus: training and education manuals
< note: training is mandatory for all staffs (incl. Top Management)
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4.1. The Strategic Management Approach
(5)
< vision, mission and all dep. objectives will be made transparent
< the Controlling department monitors and reports mbm
< the schedule for the planning process starts in August
for the next year (roll-over planning)
< the key figure is the EVA
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4.2. The Treatment of Risks and Risk
Components (1)

< whatever you do, it has a risk
< even if you dont do anything, it inherits a risk
< risks are unavoidable in business life
< companies which are risk-avers live longer
< per year, companies face about 1 million risks
(risk dilemma)
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4.2. The Treatment of Risks and Risk
Components (2)

< intelligent enterprises implement a CRO
< in fact it is a part of the Controlling Department
< there are some institutes and universities who offer risk management
courses including BA and MA degrees
< the CRO has one target: no surprise, whatever happens, he has a plan
B or C on his desk
< seminars about risk treatment are the most challenging at Universities
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4.2. The Treatment of Risks and Risk
Components (3)

ERM knows 7 Risk Components
< exposure
< volatility
< probability
< severity
< horizon
< correlations
< capital
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4.2. The treatment of Risks and Risk
Components (4)

< Risk exposure = how much can we lose as a maximum?
< Risk volatility = is the variability of potential outcomes of risks
< Risk probability = how likely a risk can occur?
< Risk severity = how high is the real damage if the risk occurs?
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4.2. The Treatment of Risks and Risk
Components (5)

< Risk horizon = when and how long can the risk happen?
< Risk correlations = how are different risks correlated positive
or negative to others?
< Risk capital = how high should we accumulate our capital to cover the
risk components, or: can we buy an insurance or
re-insurance treaty, or: should we set up a captive company?
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4.2. The Treatment of Risks and Risk
Components (6)

< Each type or Risk (see 4.3.) now will be matched with these 7 Risk
Components
< The result is a matrix with many mathematical, arithmetical and
statistical equations
< The results will be ranked (peer comparison) and matched with the
Group EVA
< The responsible leader has to explain the reasons
< The consequences will be offered as alternatives (option plans)
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4.3. The 12 major Types of Risks (ToR) in
detail and the interdependencies (1)

ToR are classified into
< internal, and
< external

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4.3. The 12 major Types of Risks (ToR) in
detail and the interdependencies (2)

< internal ToR are:
Hazard and operational risks
< external ToR are:
Strategic and financial risks
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4.3. The 12 major Types of Risks (ToR) in
detail and the interdependencies (3)
hazard risks include:
< Public access
< Misbehaviour of employees
< Products and services
these risks can lead to massive image (reputation) losses
image losses are the most dangerous risks,
they are hidden, uncontrollable and unpredictable
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4.3. The 12 major Types of Risks (ToR) in
detail and the interdependencies (4)
Operational risks include:
< Recruitment (HR risks)
< Supply chain
< Business operation
< IT
< Internal Regulations
< Cultural
< Top Management
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4.3. The 12 major Types of Risks (ToR) in
detail and the interdependencies (5)
Strategic Risks include:
< Competition per product and market
< Customer demand changes
< Regulatory and political changes
< M+A reactions (80 % of all M+A go bust)
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4.3. The 12 major Types of Risks (ToR) in
detail and the interdependencies (6)
Financial Risks include:
< Interests and foreign currency exchange risks
< Credit risks
< Inflation risks
< Purchasing Power
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4.3. The 12 major Types of Risks (ToR) in
detail and the interdependencies (7)

the variation of risks:
< Time to time
< Country to country
< Sector to sector
< Quality
< Quantity
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4.3. The 12 major Types of Risks (ToR) in
detail and the interdependencies (8)
< the biggest risk is the Market Risk
It is related to the P M S Strategy of a company
< the BMT is the Marketing Management
< rule: the more international, the more excellent the P-M-S Strategy
< market risks cannot be avoided, just minimized
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4.3. The 12 major Types of Risks (ToR) in
detail and the interdependencies (9)
the second biggest risk is the efficiency achievement risk
It is related to:
< Quantities (output)
< Qualities (search for excellence)
< Work flow structure
< Time (on-time delivery)
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4.3. The 12 major Types of Risks (ToR) in
detail and the interdependencies (10)
< its key figure is the EVA
< are we efficient and effective?
< what jobs, products etc must be deleted or re-designed?
< the inefficiency achievement risk is dangerous because it is a
hidden risk
< many Chinese companies say: we work hard, we try our best
Instead of: we will be efficient.


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4.3. The 12 major Types of Risks (ToR) in
detail and the interdependencies (11)
the third biggest risk is the liquidity risk
< it is related to insufficient cash flow, working capital, bank credit
facilities, supplier credit
< it may lead to a fast death of the company
(liquidity is like drinking, profit is like eating)
< a good manager cares first about the cash flow
< at my MBA courses in finance, I focus on cash flow management
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4.3. The 12 major Types of Risks (ToR) in
detail and the interdependencies (12)
Nr. 4 is the credit and commercial delinquency risk
< it is related to the inability or unwillingness of the buyer to fulfill his
contractual obligations
< it is the first ToR which can be insured, the first 3 ToR cannot be
insured
< the respective insurer is the Credit Insurance
< A credit insurer is a mixture of a huge bank and a huge insurer
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4.3. The 12 major Types of Risks (ToR) in
detail and the interdependencies (13)
< case studies prove what really happens if a buyer goes bust
< a credit insurance offers 7 big advantages
< the indemnification of a loss is just one of them
< 80 % of the FORTUNE 500 use credit insurance
< some sectors in the West use 100 % credit insurance
< 30 % of insolvencies are caused by domino effects
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4.3. The 12 major Types of Risks (ToR) in
detail and the interdependencies (14)
< in the West, if a CEO or CFO or MD loses big money due to a default of a
buyer and he has not signed a credit insurance, he will be fired
< big insolvencies come overnight (sudden death) and no supplier has any
chance to react
< the biggest advantage of a credit insurance is that it automatically covers
or eases the first 3 biggest ToR
< This is the reason why it is so popular in the West
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4.3. The 12 major Types of Risks (ToR) in
detail and the interdependencies (15)
the 5. th biggest is the IT (MIS) Risk
< a break-down of the IT-system and no back up function can kill the
whole business
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4.3. The 12 major Types of Risks (ToR) in
detail and the interdependencies (16)
the 6 th biggest risk is the legal risk
< it is related to (insufficient) laws, regulations, court actions, IPR
problems etc in the various countries
< it is closely related to political risks
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4.3. The 12 major Types of Risks (ToR) in
detail and the interdependencies (17)
the political risk is the 7 th biggest risk
< it is related to the internal and external stability (country ceiling)
< all Rating Agencies, Banks and Credit Insurer offer Country Ratings
< however: all ratings are subjective and many Rating Agencies in China
do not match quality standards.
< Moreover: the big 3 international Rating Agencies (US based) were
heavily negative involved in the current financial crises
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4.3. The 12 major Types of Risks (ToR) in
detail and the interdependencies (18)
Nr. 8 is fraud, embezzlement and corruption
< this applies to the West, in China this risk is nr. 2
< in the West losses caused by these risk are higher than fire damages
< In the West, this risk can be insured, but not in China
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4.3. The 12 major Types of Risks (ToR) in
detail and the interdependencies (19)
nr. 9 is the capital risk
< it is related to the whole capital + funding of a company
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4.3. The 12 major Types of Risks (ToR) in
detail and the interdependencies (20)
nr. 10 is the environment risk
< this applies to the West
< in China this risk nr. 3
< it is related to the contamination of air, water, ground
< in China, water will become nr. 1 risk soon
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4.3. The 12 major Types of Risks (ToR) in
detail and the interdependencies (21)
Nr. 11 is the elemental force risk
< it is related to all natural disasters
< in China this risk is much higher (earthquake, typhoon, draught)
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4.3. The 12 major Types of Risks (ToR) in
detail and the interdependencies (22)
Nr. 12 is the epidemic disease risk
< to day it is a global risk (SARS, bird flu, swine flu)
< it can damage a whole economy
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4.4. The Experiences in the West with ERM



< companies using ERM gain in average a 25 % higher profit
< their shareholder value increased 28 % higher than others
< in Germany, due to a special Risk Transparency law, all listed companies
have to follow the ERM approach
< in the US, SoX Act 404 stipulates similar tools, but
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Chapter 5:How to proceed in reality in
China when using ERM?
Some practical advises
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5. How to proceed in reality in China when
using ERM? (1)

< in 2007, the Central Government has released a regulation that all
companies step by step have to follow ERM
< first the banks, then the insurers, then the SOE
< however: the implementation ratio has reached about only 11 %
< a better and faster way, is to offer seminars, work shops for the local
enterprises in the different provinces
< every good idea needs a promoter
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5. How to proceed in reality in China when
using ERM? (2)
in reality, ERM starts with a SWOT, based on many check lists
there are 4 different concepts which have been approved:
< The short and concentrated assessment
< The concentration on one ToR
< The training of the staffs
< a combination of these
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5. How to proceed in reality in China when
using ERM? (3)
< another concept is lead by a foreign expert to implement a risk working
group on city - or provincial level
< this group can work out guidelines
< the foreign expert can train the group members
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5. How to proceed in reality in China when
using ERM? (4)
< also, a good solution is to set up special sector risk working groups
< they are lead by the foreign expert and concentrate only on one sector and
its risks (may be: chemistry or machinery etc)
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Chapter 6: Q + A
76
Xiexie
Contact me:
Contact: wolf.kersten@gmx.de
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Abbreviations used (1)



ABS = Asset Backed Securities
BMT = Basic Management Tools
BTBU = Beijing Technology + Business University
CDS = Credit Default Swaps
CEIBS = China European International Business School
CEO = Chief Executive Officer
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Abbreviations used (2)
COO = Chief Operating Officer
CP = Commercial Paper
CRO = Chief Risk Officer
CV = Curriculum Vitae
ECUST = East China University of Science + Technology
EDP = Expert Data Pool
e.g. = example given
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Abbreviations used (3)
ERM = Enterprise Risk Management
EU = European Union
EVA = Economic Value Added
GDP = Gross Domestic Product
G-20 = Top 20 country leader meeting
IFC = International Finance Corporation
IT = Information Technology
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Abbreviations used (4)
M+A = Mergers + Acquisition
MBA = Master of Business Administration
MBS = Mortgage Backed Securities
MD = Managing Director
Mio = Million (s)
m-p-m = month per month
PMS = Product-Market-Sales
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Abbreviations used (5)
Q+A = Questions + Answers
SIBFI = Shanghai International Banking + Finance Institute
SoX 404 = Sarbanes Oxley Act Nr. 404
STS = Short Term Selling
SWOT = Strengths, Weaknesses, Opportunities, Threats
TCM = Traditional Chinese Medicine
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Abbreviations used (6)
ToR = Types of Risks
UK = United Kingdom
US = United States
USD = US Dollar currency
USP = Unique Selling Proposition
y-o-y = year on year