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IMPLEMENTATION OF THE ERM MODEL

 

Corporate governance

The Sarbanes Oxley Act, which was created in 2002 to prevent corporate fraud, was the reason for the rise of the importance of corporate governance. Hence the ERM requires that the following management responsibilities be assigned: to define a firm’s “risk profile”; this means it is required to evaluate the firm’s willingness to take risks and threats and the possible outcomes. This is important to determine proper investment asset allocation. Also, to ensure firm has necessary risk management skills. Risk management skills involves the risk management process which consists of 5 steps: risk assessment, risk analysis, risk treatment, risk acceptance, and risk communication. Thirdly, to establish the organization’s structure with all roles and responsibilities. This involves assigning different enterprise risk management roles throughout the organization, and establishing a clear hierarchy structure.

Risk management integration also plays an important role in corporate governance. This means identifying the degree of harm derived from a certain threat or risk and balancing the costs and benefits of the possible methods to eliminate or reduce the risk. It is crucial to establish risk assessment and audit processes to avoid corruption within a corporation’s risk management process. There must be auditor’s who authorize the decisions of the risk managers before they are implemented.

Setting the risk culture of the firm starting at the top: The CEO is an important step in corporate governance. Establishing a hierarchy chart for the company’s risk management roles is a critical step to ensure clear communication of the tasks and duties in the ERM process. It is also important to create an ongoing employee training program; a strong employee training program means there is less employee mistakes therefore less money wasted within the corporation, and this could also avoid big issues such as bankruptcy or bad company reputation.

Management 

Using the concept of Line vs Staff Positions in the Firm ERM means that in certain situations the line managers should seek advice from the staff beneath them. Using the Line Vs Staff concept does the following: aligns the production process with the corporate  risk policy, incorporates expected losses and cost of risk capital  into production pricing and the hurdle rate, and creates an efficient and transparent risk review  process to give production managers better  understanding of acceptable risks.

This should help reduce the volatility of the company’s earnings, thus enhancing shareholder value. With an organized approach to risk, a firm can better manage its risks and returns to make more informed decisions about capital and investments.

Portfolio management

ERM requires that management act as a portfolio fund manager who identifies the firm’s risk profile which is essentially a representation at a given point of time of an organization’s overall exposure to risks. ERM also requires that management set risk limits within a range of risks. When risk taking is authorized, risk limits are bounds placed on that risk-taking decision.

ERM produces diversification benefits for the company. Diversification benefit arises when two processes are not completely dependent on each other, and a bad (good) outcome for one process does not necessarily mean a bad (good) outcome for the other. Dependency and diversification are opposite sides of the same coin; when the strength of a dependency is increased, the level of diversification benefit is reduced.

Reference:

https://www.value-at-risk.net/risk-limit/

https://www.pwc.com.tr/en/assets/about/svcs/abas/frm/operationalrisk/articles/pwc_enterprisewiderisk.pdf

https://www.theirm.org/media/1454273/IRM_Diversification-Booklet_hi-res_web-Final.pdf