Business Finance - Management Financial Risk Management Assignment
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20-03-54_SampleAssignment_FRM.pdf
ELECTRONIC ASSIGNMENT COVERSHEET
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Course Extended Diploma in Finance and Risk Management
Unit Name Financial Risk Management
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09/11/2023
LEARNING OUTCOMES AND ASSESSMENT FEEDBACK
Name of the Assessor
Module Title Financial Risk Management
Module Learning Outcomes
LO1 Critically discuss the building blocks of risk management
LO2 Critically assess how firms manage financial risk
LO3 Critically discuss the Governance of Risk Management
LO4 Critically analyze models for valuing financial portfolios
Assessment Types Marks Marks Achieved
Project Format
Introduction – Profiles of Organizations selected 15
Critically discuss the building blocks of risk
management 20
Critically assess how firms manage financial risk 25
Understand the Governance of Risk Management 20
Critically analyze models for valuing financial portfolios 20
Overall Score 100
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Overall Feedback on
current work with
emphasis on how the
student can further
improve in future.
The following grading criteria will be applicable for the course, Executive Diploma in
International Business and Strategy:
Marks Grade
70 to 100 A - Distinction
60 to 69 B - Merit
50 to 59 Pass
40 to 49 Fail with Resubmit
0 to 39 Fail with Retake
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Assignment Financial Risk Management
Learning Outcome 1: Critically discuss the building blocks of risk management.
▪ PC 1.1: Critically discuss the impact of an event on the risk profile of an organization.
▪ PC 1.2: Critically evaluate the risk management process of an organisation
▪ PC 1.2: Critically evaluate the tools and procedures used by an organization to measure and
manage risk.
▪ PC 1.3: Critically assess the potential impact of operational and financial risks on an
organization.
Learning Outcome 2: Critically assess how firms manage financial risk.
▪ PC 2.1: Critically evaluate strategies for measuring risk.
▪ PC 2.2: Apply risk mitigation strategies to operational and financial risks.
▪ PC 2.3: Critically discuss current risk management issues and strategies adopted by firms.
Learning Outcome 3: Critically discuss the Governance of Risk Management
▪ PC 3.1: Critically discuss best practices in corporate governance in relation to risk
management.
▪ PC 3.2: Critically discuss the interdependence of functional units within a firm with risk
management.
▪ PC 3.3: Critically assess the role and responsibilities of organizational audit committee in
managing complex ethical issues.
Learning Outcome 4: Critically analyze models for valuing financial portfolios.
▪ PC 4.1 Conceptualize the challenges in decision making using two financial modelling
techniques.
▪ PC 4.2 Critically evaluate the components and derivation of the Capital Asset Pricing Model
▪ PC 4.3 Undertake critical evaluation for the application of the Capital Asset Pricing Model
Assignment Task Report [100 Marks] [6000 Words]
Read the following Scenario and prepare a Formal Business & Financial Review Document with
the guidelines provided.
Scenario:
For answering the questions, you must demonstrate an understanding of risk management strategies
and models adopted and implemented by the organization within a particular sector in dealing with the
impact of COVID-19. Here you can select the company and sector of your choice.
You are required to present a Formal Business Report, that would contain a neatly designed Table of
Contents to capture the main and sub-topics in an orderly fashion which should adhere to meeting the
assessment standards and grading criterion:
a.) Briefly give a background of the chosen organization, it’s industry and impact on its risk
profile due to pandemic.
b.) In reference to the chosen organization, critically evaluate the risk management process
adopted by the company detailing quantitative and qualitative approaches used to measure and
manage the risk due to pandemic COVID-19. Further, classify these risks into operational and
financial risks and critically assess their intensity of impact within different functionality of
the company. This could be conceptualized by means of an illustrative model such as matrix,
bubble chart or any similar tool.
c.) As a response to prepare for the implications due to COVID-19, demonstrate application of
hedging strategies for managing operational and financial risks. Compare and contrast
mitigation strategies, with detailed assessment of tools like derivative instruments. Review
recent research academic and non-academic articles to demonstrate awareness of the current
issues and critically discuss strategies of risk management adopted by the firms during
pandemic.
d.) With adequate evaluation of risk management strategies above, critically discuss the best
practices of corporate governance implemented in the industry of chosen organization.
Critically discuss their interrelationship with the risk management strategies. To keep
strategies in adequate implementation, draw critical arguments in assessing the roles and
responsibilities of audit committee in managing ethical issues, especially in the challenging
times wherein strategic transformation and adaptation has been a key measure.
e.) The risk management strategies have evolved with time and macro-economic challenges;
therefore, critically analyze the challenges faced in applying two modelling techniques. In the
same parlance, conceptualize and interpret modern portfolio theory with Markowitz efficient
frontier. Understand and critically evaluate the components of Capital Asset Pricing Model.
Critically discuss the application of CAPM model in the current scenario using wide range of
resources.
Note:
1. For answering the questions above, chosen organization and its industry should be used as the
basis for analysis and application of academic concepts, considering the response to COVID-
19 as the underlining theme for the report. Any comparison, contrasts with competitors and
recommendations can be included. Support answers with data and research.
2. Presentation & References: You should present the whole document in methodical manner
and should remain aligned to appropriately demonstrate correct application of the Harvard
Referencing System (HRS).
Performance Descriptors
Performance descriptors indicate how marks will be arrived at against each of the above criteria. The
descriptors indicate the likely characteristics of work that is marked within the percentage bands
indicated.
Assessment
Criteria
(70-100%)
Work of an
outstanding,
excellent & v. good
standard (*)
(60-69%)
Work of a good
standard.
(50-59%)
Work of a pass
standard.
D (40-49%)
Fail
E (0-39%)
Fail
Understand the building blocks of risk management (15+20%)
Assignment produces an excellent analysis of the operational and financial risks by reviewing the risk management decisions in a well explained manner to present its significance, by draw comparisons across peer group companies within the segment. Additionally domain specific industry reports are reviewed to narrate current macro- economic events which provide and propose reasons for changes with comparisons by stating means of improvement futuristic goals including quantitative and qualitative measures. Excellent understanding demonstrated to critically examining judgements and estimates used for analyzing the potential impact of each type of risks within organization. Application and critical analysis to be demonstrated for risk management.
Assignment produces accurate & relevant information to evidence and support factual analysis of companies operational and financial risks which produced accurate accounting and management decisions ,that have been reasonably explained as to their share its significance, draw comparisons within the segment. Additionally domain specific industry reports have been reviewed to capture the current macro- economic events in a satisfying manner to provide and propose reasons for changes with comparisons by stating means of improvement futuristic goals including quantitative and qualitative measures. Good understanding demonstrated to critically examining judgements and estimates used for analyzing the potential impact of each type of risks within organization. Application and critical analysis to be demonstrated for risk management. Grammar & spelling
Assignment produces a fairly good narrative to support factual analysis of companies operational and financial risks by reviewing the relevant company ‘websites’ & Wikipedia sources in a limited manner to produce necessary details of accounting and management decisions , which have reasonably explained as to demonstrate its significance, but a bit inconsistent, when drawing comparisons within the segment. Some errors spotted in grammar and syntax Fairly reasonable understanding demonstrated when commenting on judgements and estimates analyzing the potential impact of each type of risks within organization. Application and critical analysis to be demonstrated for risk management.. Some inconsistencies in grammar & syntax observed.
Assignment produces a poor review in support of factual data analysis with respect to company’s operational and financial performance. Evidence presented is of limited manner in not reviewing necessary Annual Reports to produce required details of accounting and management decisions .Explanations are in a language that is not fluent to contain inaccurate grammar Some errors & inconsistencies sighted in information produced. Presentation is poor in structure relevant concepts when reviewing the judgements and estimates and includes errors in grammar and syntax. Not very coherent as language is inconsistent.
Assignment fails to provide any significant review to support factual data analysis with respect to company’s operational and financial risks. Structure, language grammar and presentation of information is not of an acceptable standard including faulty syntax. Purpose of the analysis to present necessary views and opinions on judgements and estimated presented in poor and disorderly manner. Language is unclear and incorrect usage of grammar and syntax.
accurate and fluent. Thoughts and views clearly expressed. Presentation is orderly and of good standards, minor syntax errors sighted.
Assess how firms manage financial risk (25%)
Assignment produces an excellent analysis of the company’s performance which includes relevant information on financial risk management , which have been explained as to their role, comparisons provided and proposed reasons for changes, differences with comparisons and means of improvement by understanding
management of the
risk exposures, hedging risk
exposures, foreign
currency risk and potential impact of
risk management
tools, supported with reviewing recent
research articles.
Assignment produces a very good analysis of the company’s performance which includes relevant information on financial risk management , which have been explained as to their roles, comparisons, proposed reasons for change, differences with comparisons and means of improvement
Assignment produces an analysis of the company’s performance which includes relevant information on financial risk management , which have been explained as to their roles, comparisons and proposed reasons for change, differences with comparisons and means of improvement
Assignment produces a limited analysis of the company’s performance which misses some of the key elements and supporting detail.
Assignment produces a limited analysis of the company’s performance which misses most of the key elements and supporting detail.
Understand the Governance of Risk Management (20%)
Assignment produces a clear and concise critical analysis of the best practices in corporate governance. This analysis recognizes changing economic environments, interdependence of functional units. Demonstrate interrelationship between risk management strategies, this can be supported with a diagrammatic representation to enhance the understanding. Excellent clarity of
Assignment produces a clear and concise analysis of the best practices in corporate governance. This analysis recognizes some of the issues around the changing economic environments, interdependence of functional units within the company. Thoughts and ideas clearly expressed. Grammar and spelling accurate and fluent. Presentation overall of good standard with few errors in grammar and syntax. Referencing relevant
Assignment produces an analysis of some the best practices in corporate governance. This analysis recognizes some of the issues around the changing economic environments, interdependence of functional units. Presentation has limitations including some errors in grammar and syntax Minor inconsistencies and inaccuracies in referencing using the Harvard system
Assignment produces an analysis of a few best practices in corporate governance. This analysis fails to recognize the main issues around the changing economic environments, weakness with interdependence of functional units. Meaning apparent but language not always fluent, grammar and spelling is often inaccurate. Presentation is poor in structure and
Assignment fails to produce an analysis of the best practices in corporate governance. This analysis fails to recognize the main issues around the changing economic environments, interdependence of functional units. Purpose and meaning of assignment unclear. Language, grammar and spelling poor. Structure and presentation is not of an acceptable standard including faulty grammar and
expression. Consistent/ accurate use of grammar and spelling using an academic writing style. Presentation standard of the assignment is excellent; consistent with academic protocol. Referencing clear, relevant and consistently accurate using the Harvard system
and mostly accurate using the Harvard system.
includes errors in grammar and syntax. Referencing present having many inconsistencies and inaccuracies
syntax. Referencing mainly inaccurate or absent
Understand the modern portfolio theory and capital asset pricing model (20%)
Excellent Academic Debates are presented when reviewing necessary challenges and inherent difficulties in decision-making using modern portfolio theory, Markowitz and CAPM model. Markowitz frontier to be included in the form of a diagram or graph. CAPM model can be supported with equation or graph. The clarity is excellent and supported with adequate citations. Harvard Referencing System followed in a systematic and accurate manner.
Sound Academic Debates are presented when reviewing necessary challenges and inherent difficulties in decision-making process using modern portfolio theory, Markowitz and CAPM model. Markowitz frontier to be included in the form of a diagram or graph. CAPM model can be supported with equation or graph. Fair understanding demonstrated through these diagrams and charts. Errors in Harvard Referencing, along with minor flaws grammar and syntax observed. Suitable recommendations post reviewing each academic theory.
Reasonably Good Academic Debates are presented when reviewing necessary challenging and inherent difficulties in decision-making of process using modern portfolio theory, Markowitz and CAPM model. Markowitz frontier to be included in the form of a diagram or graph. CAPM model can be supported with equation or graph Limited Harvard Referencing & recommendations are placed post reviewing each academic theory. Errors in Grammar and syntax
The purpose of this task does not meet acceptable standards. Lack of Academic debates sighted. Limited understanding exhibited with poor language carrying confused meaning and no structure or pattern followed when discussing the relevant investment appraisal techniques. Poor Grammar and syntax errors observed Recommendations are not in line with the academic thinking to support investment appraisal techniques for supporting long term decision- making.
The information placed fails to meet desired expected standard. Language, structure and presentation of thoughts are not fluent and is unclear. Poor use of grammar and syntax
Financial Risk Management
Table of Content
1. Introduction
2. Risk management process
2.1. Types of Risks
2.2. Risk Management Process
2.3. Qualitative Risk evaluation
2.4. Quantitative Risk evaluation
2.5. Operational Risk (OR)
2.6. Financial Risk (FR)
2.7. Impact of COVID-19 on SC’s approach to Risk.
3. Mitigation Strategies & Strategic Risk Management
3.1. Mitigation Strategies
3.1.1. Types of Derivatives
3.1.2. Derivative Products
3.2. Strategic Risk Management
4. Corporate Governance Best Practices
4.1. Corporate Governance
4.2. Principles of Good Corporate Governance
4.3. Good Corporate Governance
4.4. Corporate Governance Best Practices
4.5. Roles and Responsibilities of Audit Committee in Managing Ethical Issues
5. Risk Modelling
5.1. Value at Risk (VaR) Modelling
5.2. Potential Future Exposure
5.3. Risk Modelling used by Standard Chartered Bank
5.4. Markowitz Efficient Frontier and Modern Portfolio Theory
5.5. Capital Asset Pricing Model (CAPM)
1. Introduction
Standard Chartered PLC (SC) is considered has the organization of choice for this assignment.
SC is a large financial institution headquartered in London and incorporated as a limited
liability company in England and listed in London Stock Exchange and Hong Kong Stock
Exchange. The organization was incorporated in 1853 and is present is 59 countries and
territories through branches, subsidiaries and representative offices to serve 120 diverse
markets around the world. SC is present in Asia, Africa, Middle East, Europe and America
regions with a staff strength of over 83 thousand.
With 150+ years in the industry, SC has developed robust risk management systems which
were put to test many times during the existence of the organization. COVID-19 was one such
challenging and unprecedented event and in this paper I intend to analyze how SC is prepared
with its risk management processes to weather the COVID-19 storm and financial, economic
and social impact as a result of it.
SC’s business segments primarily are divided as Global and Local, of which Corporate &
Institutional Banking globally and Retail Banking locally are major contributors to company’s
bottom-line. Point to note here is that both these segments were heavily impacted by the where
retail clients were struggling to repay their commitments and with major disruption in transport
and logistics, businesses of Corporate Clients saw unprecedented and sudden slowdown.
SC has a large presence in Asia from where 70% of its operating revenue come from. Asia was
also one of the worst hit regions from the start if the where countries had to go on lockdowns
for extended period of time.
Risk Management and Impact on Risk Profile due to COVID-19
SC manages its risk profile through Board Risk Committee that comprise of 7 permanent
members that from time to time have the attendance of Group’s Chairman, CEO, CFO, CRO,
General Counsel, Treasurer, Head of Compliance, Head of Internal Audit, Statutory Auditor
and Company Secretary. Responsibility of this committee is to have an oversight on risk
elements of the Group, conduct impact analysis on risk management systems and make
recommendation to SC’s Board based on its analysis of Enterprise Risk Management
Framework (ERMF) and Group Risk Appetite Statement (GRAS). ERMF lays out risk
management principles and standards for the entire SC Group including its subsidiaries. SC’s
assets portfolio is divided into 3 main categorized in order to suitably respond to current and
potential risks. Assets that are not associated with increase in credit risk since origination and
impairment on the basis of 12 months expected credit losses are under Stage 1. Stage 2 are
those assets that see a significant increase in credit risk and Stage 3 Assets that are considered
credit impaired (non performing loam - NPL) and in default.
COVID-19 had a huge impact on Financial Industry and SC had to be very quick in evaluating
its current risk strategy to take actions that are necessary to protect the interest of shareholders
and other stakeholders. In the business of “Risk”, SC’s initial attempt was to evaluate its client
portfolio and their reaction to various COVID-19 related scenarios. Here, SC conducted stress
tests for various scenarios and had to focus more on certain segments of its cliental those other
segments. This assessment resulted in downgrading internal credit rating of identified clients
and countries which increased SC’s Early Alerts Exposure (that have higher probability of
default) by two folds to USD10.7 Billion, when compared with previous year’s USD 5.3
Billion. In order to curb Early Alerts Exposure to acceptable levels, management of SC
implemented strategies including imposing new regulations to reduce exposure. Measures
included placing of vulnerable sectors under watch, reducing exposure where required,
enhanced monitoring on drawdowns from facilities especially against those are committed by
the bank. Imposed restrictions across all product lines on sectors like Aviation, Oil & Gas,
Commodities Financing, Commercial Real Estate and Metals & Mining. There was also an
increase in High Risk loans (G12 not settled 30 days past due date) from USD 1.6 Billion in
2019 to USD 2.2 Billion in 2020. USD 0.9 Billion rise in impairments was reported in 2020
against 2019. Due to high market volatility on interest rates and credits spreads as a result of
COVID-19, Average Group value at risk (VaR) was USD 108 Million in 2020, which when
compared with 2019’s USD 30 Million is considerably high. Here, VaR refers an amount of
market risk estimated by SC - with reasonable care and confident that – will not exceed in a
particular period in time.
On HR front programs to cover physical and mental health of employees are reassured. On
Health and Safety (H&S) side, required measures in coordination with regulators of different
jurisdiction were implemented by the group in line with recommendations in ERMF.
Operations risk during this unprecedented period was coupled with Technology and the bank
put in place adequate measured ensure potential risks are mitigated.
(Standard Chartered Bank, 2022) (Standard Chartered Bank, 2021)
2. Risk management process
In current business environment, organizations will have to take calculated risks in order for
them to compete in the marketplace. Companies that continuously perform well take greater
risk and are subject to vulnerability. Here, it is important that companies have adequate Risk
Management processes that will systematically identify, mitigate and remedy risks that could
affect performance and stability of the organization. Being unaware of risks that have an impact
on the business may result in loss of market-share and financial losses. As such, risk in business
can be defined as potential variability of returns around the expected return. Which also means
that an adequate risk management process will have to be in place to manage potential
variability of returns to ensure that they do not vary much from expectation.
2.1. Types of Risks
In order to propose an effective risk management process, first we will have to understand and
categorize risks in to different types in order to meaningfully address them. Risks may vary
from company to company and industry to industry; though following can be considered as
primary risk types.
• Strategic Risk – involves in the overall strategic decision making to achieve desired results.
• Financial Risk – associates with cash flow, debt, losses, drop in revenue and equity risk etc.
• Operational Risk – factors that contribute the day to day operation of the business and risks
associated with them. This could be a result of human error, inadequate controls, lack of
required tools and technology failure.
• Compliance Risk – is associated with internal governance policies and regulations set by
governments, regulators and relevant external bodies
• Reputation Risk – involves company’s obligations towards its clients, creditors and the
impact on the society at large. Fairness, trust, ethics and social responsibility are factors
that need to be adequately addressed.
(Analyst Prep, 2023) (Team, 2023) (Tattam, 2019)
2.2. Risk Management Process
A framework that is in place to identify, analyze, evaluate, prioritize, treat and monitor risk.
Here, the process demands that potentials risk to project/company are identified, analyzed and
evaluated which then are treated in accordance to criticality. Monitoring is a vital part of the
process as it assesses the effectiveness of remedial actions that are put in place to minimizing
variability of returns as against the expected return.
Identify Risk
Initial step of the process where risks that are currently dealt with and/or will have to potentially
deal with in future are identified. These risks could include primary risks discussed above and
other risks that are specific to the business or operating markets; such as ESG related. It is
important that all types of risks that the organization potentially will encounter are identified.
Approach adopted during this exercise is to unearth all possible pitfalls that the identified
venture will face as it then will help address each risk against its merit. Here the team involved
in the process should tap into as much experience that is available within the organization and
conduct a comprehensive study on internal and external factors the will influence the identified
venture. Risks that are identified must be systematically recorded. Considering the importance
of this first set of Risk Management Process, Large organization have developed their own
software while others use software that can be purchased off the shelf. Some small companies
still follow the manual mapping, a process by nature itself could a risk element to such
companies.
Analyze Risk
As suggested, the team will exhaustively analyze risks that are identified to establish severity
of identified risks individually and collectively. Elaborate and accurate answers to following
on each identified risk will have to be considered at the least.
• Likelihood of occurrence,
• Significance of risk and consequence to the identified venture and the organization
Analyzing will have to be holistic and consult different business segments, support functions
and other relevant factors within the organization to understand the impact on each of those
functions. Capturing these analysis in organization’s Risk Management software is a vital part
of the process as it trigger remedial action, ensure updating of governance documentations
including policies and procedures of different business units and support functions and also
update organization’s risk management framework.
It is important for organizations, particularly for the senior leadership to be aware of severity
of identified risk and the probability of occurrence, to allocate adequate resources to remedy
these risks efficiently. Prioritizing and ranking risks will help in the decision making process
and help organizations use it scares resources optimally. Following aspects will be considered
during the ranking process.
• Potential financial loss
• Severity of the impact
• Resource availability to manage the identified risk
• Loss of time
Evaluate Risk
Once analyzed, identified risks – depending on their severity – needs to be prioritized and
ranked. It is obvious that risks that will potentially cause major losses to organizations are
ranked at the top while risk that could cause mere inconvenience will be ranked at the bottom.
Ranking will also help understand to which of those risk that senior management intervention
and strategic decision making is required and which other can be managed at a mid-
management level. Here, depending on the nature of risk, qualitative or quantitative evaluation
methods will be used.
Treat Risk
Ranked risks are assigned to experts in relevant fields to either contain or completely eliminate.
It is important to manage the process around implementing proposed remedial actions. The
mission is rather straight forward in organization that have dedicated systems where
requirements are fed into and assigned. With dedicated systems, communication between
stakeholders is on real-time and efficient. It also provide visibility to the senior management
of the organization.
Monitor and Review Risk
While some risk can be eliminated completely there are other that require constant monitoring.
These are mainly related external factors and teams responsible to remedy will have to
constantly monitor to ensure that proposed mitigation is sufficient or in need for escalation.
Against, managing the requirement through a software is more effective in many fronts
including real-time communication and audit trail. Systems also facilitate the ease of amending
a particular remedy when required, rather than going through the complete workflow.
Understanding the importance, organization have deployed qualified recourses for the risk
management and separate risk management department that constantly revisit internal and
external factors to identify potential risks and to be up-to-date with risk management processes.
These organizations have also invested software that improves efficiency, traceability and
accountability. Thanks to such electronic tools, risk management department now has the
ability to develop and manage multiple risk management frameworks. Compilation all such
frameworks, methods and technologies is known as Enterprise Risk Management (ERM)
which form an integral part of today’s organization’s business architecture.
(Thomas, 2023) (Lucidchart, 2023) (Horvath, 2023) (Safran, 2019)
SC’s through its Enterprise Risk Management Framework (ERMF), setout standards and
principles to manage various risks across branches and subsidiaries of the group. As part of
group’s core objectives, through ERMF a healthy risk culture is promoted. Guidance to
employees and their roles and responsibilities are defined in ERMF that has an integrated and
holistic view of potential risks. As shown in below diagram, SC adopts a three level defense
mechanism and identify every employee with their responsibilities depending of their job role.
SC has developed a risk culture wherein employees are expected to challenge the status-quo
when it comes to risk. In this process, the bank ensures safety of employees and even reward
proposals that will add significant value to enhance risk outlook. Operating in the “risk taking”
industry, SC’s ERMF’s objective is to maximize risk adjusted returns within Risk Appetite that
is considered acceptable. ERMF is the responsibility of The Group Chief Risk Officer (CRO)
whose team is responsible for identifying and analyzing potential risks and propose Risk Type
Frameworks (RTF) which in other words are action plans. CRO delegate RTFs to Risk
Framework Owners (RFO) who are designated to provide second level defense and oversight
for Principal Risk Types (PRT).
CRO office use PRT primarily to categories risk exposures, though due consideration is given
to other factors to uphold the overall perspective. As part of ERMF, it is also the responsibility
of CRO office to manage risk associated with relevant external factors including 3rd party
suppliers. During risk management process, the CRO office tap into a wide range of resources
both internally and externally for inputs to identify internal weaknesses and external
opportunities and threats. ERMF contains historical records of PRTs and other sub-types
(which are inherent to SC’s strategy and business model) along with risks that emerge out of
near term uncertainties. ERMF also have information on risks that may emerge out of long
terms uncertainties for close observation purposes.
Below diagram defines risk that SC consider as Principal Risk Types (PRT)
Reports on risk profile of PRT prepared by CRO office is regularly reviewed by Group Risk
Committee in consultation of group’s Risk Appetite, historical records and risks emerging out
of short term uncertainties in order to identify and escalate material changes in each risk
category and to make appropriate recommendations to the Board. ERMF is reviewed at least
once every year and approved by the Board based on recommendation from Board Risk
Committee for all PRT except Financial Crime Risk, which will be supported the Board
Financial Crime Risk Committee. Ultimate responsibility for managing risk lays with the Board
that is supported by 6 Board level committees (see diagram below).
In the financial industry, counterparty credit risk is the top most risk that requires due and
timely attention. Short terms and long terms uncertainty that COVID-19 created was
unprecedented and companies had to immediately assess risks that they are exposed to in the
short term and on the long run.
SC immediately identified and assessed Significant Increase in Credit Risk (SICR) by
comparing the risk of default at origination of an asset with its current risk of default. Results
of this comparison is further assessed using qualitative and quantitative criteria’s to evaluate
its significance to SC’s business.
On the quantitative side, revised meaningful SICR thresholds were defined for each Business
line. Considering this exercise is to create an intermediary risk tier which will have
counterparties that have the potential move towards the “Default” territory. These revised
thresholds were calibrated based on the following;
• To minimize accounts from being move to and forth between the intermediary risk tier to
default risk tier, and
• To build the intermediary tier with accounts that have higher tendency to move towards the
default tier, and
• Sufficient enough, where larger number of counterparts are captured under the intermediary
tier as a consequence of movement in forward looking Default probability (PD)
• In line with risks associated with different products and business processes.
As far as qualitative criteria is concern the approach adopted is placing loans (assets) under
Non-purely Precautionary Early Alert (NPPEA), primarily due to deteriorating macroeconomic
conditions. A NPPEA asset is the one that shows risk or potential weakness that require close
monitoring. SC views that such risks/weaknesses if not attended to immediately will result in
delays in repayment and run the risk of being downgrades to lower risk tiers. Lowering of credit
rating has various connotations which includes loss of market share, concerns over ability to
manage operations, accumulation of over dues, strain on liquidity etc. Hence, SC applies
judgement of experts when assessing risk of entities whose credit rating is lowered in order to
understand the extent of risk as rating models may not fully capture qualitative aspects;
particularly that related to the COVID-19.
Below table is a comparison in SICR across different business units between FY2020 and
FY2019, which show significant uptick is each risk category as a result of various qualitative
and quantitative assessment made in ERMF which can be attributed to COVID-19.
2.3. Qualitative Risk evaluation
Measure the likelihood of a risk from occurring and its overall impact when it occurs. Though
this will be an assessment that tends to be subjective, through standardized assessment
processes the approach could still ensure objectivity in determining severity, the primary goal
that organizations wish to achieve through this evaluation method. Results could then be
plotted into a risk assessment matrix in order for management to have a clear view of perceived
risk and its severity.
Commonly used techniques to analyze Qualitative Risk
Delphi Technique: Involves appointed experts brainstorming on a project and on all associated
risks. Independent identification and assessment of risk of each expert is further discussed till
such time all risk associated with the project are identified and assessed and the management
has responses to all its concerns. This process may take a long time as project owners may have
to correct misunderstandings and misrepresentations that may arise during the cause of
discussions and at submission of reports on early findings.
Risk Probability and Impact Assessment: Assessing identified risk against company’s
strategic goals and growth ambitions to evaluate likelihood occurring and severity of
consequences when it happens. Results are plotted in scale as that is shown below to determine
acceptability of identified risks. Risk associated with every aspect of a project is evaluated.
SWIFT Analysis – Various internal and external factors that will have an impact on a project
is strategically evaluated and plotted in to Strengths, Weaknesses, Opportunities and Threats
(SWOT) to understand organization’s ability respond or survive the identified risk(s). Here,
internal factors will be under Strengths and Weaknesses while external factors will be analyzed
under Opportunities and Threats.
Decision Tree Analysis – Involves evaluating all identified all possible outcome of an
identified scenario or event and rank them according to probability of that outcome
materializing. Result of this study will help identify the most suitable outcome that is most
desired for the project.
Bow-tie Analysis – Get its name from the shape that the chart takes, that us used in recognizing
the relationship between “cause” and “effect”. The most practical method that helps identify,
assess and develop mitigating strategies for identified risks. The method intends to look at an
event from two sides. On the one side its demands listing of all potential causes that may
become threats to the identified project and on the other side expects to list down all potential
outcome/effects that are expected as a consequence. When “causes” and “effects” are identified
adequate controls to prevent/ minimize impact of causes and measures to mitigate potential
outcome/effects could easily be identified and implemented.
(Juma, 2022) (Shuttleworth, 2017) (Many Caps Consulting, 2020)
2.4. Quantitative Risk evaluation
As suggested, evaluation is based on data that is verifiable, thus the process is expected to
provide responses that are objective. Solely depend on data provided, result of this exercise
give a number against each identified risk that will point towards a percentage of occurrence
for decision makers to decide on the way forward. Here, accuracy and quality of the data that
is provided will drive the outcome. Risk associated with finance are generally asses using this
method.
Commonly used techniques to analyze Quantitative Risk
Monte Carlo Analysis – A mathematical approach that uses statistical modelling and random
sampling to simulate possible outcome of a project that is complex. Here, overall cost
associated with the project is plotted against completion date or overall time taken for the
project to complete. As shown below, after plotting cost and time, a range of outcomes is
proposed for management to have a sense of associated quantitative risk.
Scenario Analysis – Vary useful technique that provides alternate perspectives on a project
and helps identify requirements at a micro level (resource allocation, risk tolerance etc.) against
each scenario contemplated. This gives a range of options for business leaders to help decision
making. Process adopted is depicted below.
Though there are no standard ways of preparing scenario planning, it can be said that the
following templates are commonly used.
Decision Tree Analysis – A visual depiction of evaluating risks associated amongst different
choices that can be contemplated. As shown below cost is tagged into to decisions are expected
to be taken and the final outcome will be functions of these costs depending on probabilities
contemplated. Once the exercise is completed the most desired outcome may be selected.
Below diagram show a simple Decision Tree Analysis where returns on different types of
CAPEX expenditure is analyzed.
Sensitivity Risk Analysis – Technique to understand the relative impact that a change in input
variables have on the target variable. Here target variable is analyzed alongside various
dependent and independent input variables to determine the impact. This will also show the
impact of a vague element in the overall project where other elements is up to a minimum
standard of expectation.
Expected Monetary Value or EMV Analysis – technique here is to facilitate decision by
establishing the relationship between expected profits/loss and probability of occurrence.
Mathematically, EMV is the summation of probability percentages of identified events from
happing and final monitory impact. Below illustration with values explain calculation of EMV
that facilitate the decision making process.
(Team, 2023) (Educate 360, 2023) (Post, 2023) (Visual Paradigm, 2023) (FONSECA, 2022)
(CFI, 2023) (Shuttleworth, 2017) (BRAINBOX, 2021)
2.5. Operational Risk (OR)
SC’s ERMF recognizes OR as an inherent risk which form part of PRT and the fact that it could
lead to potential losses. OR in ERMF is mapped as failed or inadequate internal processes,
human error, technology driven or impact of external factors.
Operational Risk profile
COVID-19 brought about a huge operational challenges where companies had to continuously
offer services to its clients while lockdowns and quarantine regulations had a massive impact
on mobility of operations staff. SC was quick to implement a work from home (WFH) policy
in order to provide continues service to its clients. The organization, in 2020 implemented a
revised Operational Risk Type Framework (ORTF) to manage OR under the new way of
working which had to include elaborate mitigating elements to risk sub types in the ORTF
associated with Fraud, Privacy and Information & Cyber Security. Other risk sub types in
ORTF including governance, reporting & obligations, operational resilience, third party vendor
management, client services, people management and safely and security also were adequately
updated to capture potential OR while operating in COVID-19 environment.
ORTF is jointly under the responsibility of Global Head of Risk, Functions and Operational
Risk (GHRFOR) which identify potential OR, set standards for risk management process and
assign roles and responsibilities to subject experts in second level of defense. Once ORTF,
through Control Self-Assessment (RCSA) roles and responsibilities to identify, control and
monitor of OR are defined.
Measuring operational losses prior to the verses during the can be considered as an accurate
indicator of robustness and effectiveness of the new ORTF that is related to a non-financial
PRT. As shown in below diagram Operational Risk RWA (Risk Weighted Assets) in reduced
by 3% in FY2020 when compared with FY2019, which reduction - as identified in Annual
Report of FY2020 is – attributed towards a specific asset disposal. As such, it could be
mentioned that measures implemented in line with ORTF are robust and effective.
2.6. Financial Risk (FR)
An organization that is successful for more than 150 year in the Banking industry, SC has
robust mechanisms build into ERMF along with factors to mitigate potential risks. Having said,
the organization had to reinforce its defensed to meet challenged that come along with the
COVID-19 .
Over the years SC had focused on improving quality of its client portfolio help SC become
resilient and overcome devastating consequences during COVID-19, even though led
deterioration in asset quality - as identified during SICR process – led to substantial increase
in provisioning against expected credit losses and higher impairements. Though SC saw a
rebound in credit risk by Q3 of 2020 the group remained vigilant as the recovery was uneven.
Though full year USD 2.294 Billon was reported at credit impairment in FY2020 explains the
40% decrease in operating profit, which in FY2019 was USD1.388 Billon. Good news is that
from first half of FY2020 the worst hit period there has been a reductions of USD 840 Million
and the last quarter of FY2020 was almost flat when compared to Q4 FY2019. Impairment
reported in FY 2020 denote a loan-loss rate of 66 bps as against 27 bps of FY2019.
As mentioned in the introduction, significant share of income come from Asian market and
Retail and Corporate and Institutional Banking segments. Pre-provision income of the Retail
segment was down by 3% in FY2020, irrespective of income from deposits decline by 26%; a
phenomenal largely due to lower interest rates and reduction in household income as a result
of the . Having said, SC’s decisions to reclassify counterparty risk and charge credit
impairment that is almost double than that of the previous year, saw a 26% decline in profits
in FY2020. Similarly, though Corporate and Institutional Banking saw a marginal 2% growth,
the same was offset by higher impairment resulting in 18% decline in profits in FY2020. When
regions of SC are concerned Grater China profits declined by 2%, which after credit
impairment was declined by 16%. It should be noted here that almost 81% of group’s income
is generated by this region. ASEAN & South Asia region saw a growth of 4% which declined
to 24% after impairment. It was noted that credit quality in Middle East and Africa regions was
better when compared as though there was 8% declined income, which was only 13% decline
after credit impairment.
2.7. Impact of COVID-19 on SC’s approach to Risk.
By incorporated COVID-19 into SC’s stress scenarios the bank could identify potential areas
of vulnerability. In addition updating ORTF (as discussed earlier) SC decided in to include
Sustainability Risk to the existing the Reputational Risk PRT. Reinforce responsibility on
enforcement of ERMF by business units and experts with oversight provided by Conduct,
Financial Crime and Compliance (CFCC). CFCC with renewed powers are responsible to
review and challenge the first line of defense in identifying risk and implementing ERMF.
Special emphasis was given to risks related to large scale continuous WFH scenarios to embed
adequate control measures in ERMF.
(Standard Chartered PLC, 2021)
3. Mitigation Strategies & Strategic Risk Management
3.1. Mitigation Strategies
As a concept, Hedging is a strategy that intends to protect value of investments from
uncertainties and volatility in financial markets. Businesses will have to protect their predicted
profit margins in order achieve expected returns. This is often a challenge due to
unpredictability of market conditions. Hence, organizations resort to solutions that will protect
their costs at least in short to medium terms and hedging solutions exactly provide the kind of
protection that is required. As such, organization’s risk management process can include
hedging solutions as a risk-mitigating factor. Though hedging organizations could effectively
manage cost associated with raw material purchases (especially commodities prices), interest
rates, currency risk etc.
Principal around hedging is, to create positions for different investments/assets that have
opposing correction to one another. Compensate losses made by one investment/asset with
gains that the other made. Having said, the process around offering a robust hedging program
is a rather complex and require expertise.
Derivatives are the most common form of hedging. They are types of financial securities linked
to specific financial instruments, stocks, commodities, bonds, currencies, interest rates and
market indexes. Though value of the financial derivative is based on underlying investment,
they both will have to be treated as different transactions. Here, two or more parties enter into
contracts and the underlying financial risk is traded in financial markets. There are multiple
usage for derivatives, of which speculation and leveraging position includes apart from Risk
Management.
3.1.1. Types of Derivatives
Derivatives are used for a wide range of purposes, which amongst others include risk
management. Products under the derivatives are classified into two main sub-sects, depending
on commitment that identified parties have in them.
• Lock – Here partied agreed on terms from the beginning and over the life of the product.
Swaps, Forwards and Futures are products that can be listed under Lock
• Option – This give the holder the right trade the underlying at a specific price on or
earlier that the expiration date. Having said the holder is not obliged to do so. Stock
option can be mentioned as an example
3.1.2. Derivative Products
Futures
These are standardized contract between two parties wherein there is an agreement to deliver
and purchase an identified asset at an agreed price on an agreed future date. Futures are traded
on an Exchange. If we consider the commodity cargo as an example, the seller here is obliged
to deliver the cargo at the agreed rate on the expiry date of the futures contract irrespective of
price of cargo at maturity of the contract and the buyer is obliged to purchase the same at the
agreed rate. In the event that there is a sudden spike in price and cargo value is expected to be
higher than the price agreed in the Futures contract the buyer has the option to sell this Futures
contract prior to its expiration date (instead of taking delivery of the cargo) and keep the profit.
In “Futures”, both involved parties expect to benefit when they enter into the contract. The
Buyer wanted to avoid a long position due escalation while the Seller wants to sell short, with
the drop in price. A point to note here is that it could be that both buyers and seller are
speculators with contrast view on the identified cargo’s price direction. In future contract one
could go either long or short depending on perception of the market. As shown in below
diagram, one will go short when a fall in price is predicted and vise-versa.
Cash Settlements of Futures, is when Futures contracts are settled prior to the expiration. Cash
settlement is a typical feature when speculative investors and traders are involved. Here,
contracts will be closed (unwind) prior expiration with gain or loss from these contracts going
to the account of brokers.
Forwards
Forwards have similar characteristics of Futures though they are over the counter (OTC)
contracts. As such, Forwards are not traded in an exchange and can be customized according
to needs of buyer and seller. As they are OTC products, they carry a higher degree of
counterparty risk for either side, where one or both parties may not be able to fulfil obligations
against them mentioned in the contract. Forwards can be created with the participation of two
or more parties; which further increases risk associated with counterparties.
Swaps
Swaps related an exchange between two kinds of cash flows, which included different
currencies and interest rate types. Consider paying interest at a variable rate of interest and the
uncertainty of rising interest cost. In such a scenario, companies can resort to Swaps as a
solution and enter into a Swap agreement with a party (a Bank) to turn this variable interest
rate to fixed interest rate at a slightly higher margin as determined by the Bank and agreed
between both parties. Upside for the company is that it would have fixed the risk of running a
loan that is subject to interest rate rise at a cost that is agreed and fixed upfront. It could be
mentioned, that Swaps associated with potential defaults/cash flows and cross currency have
caused serious damage to organisations as they were done without proper due diligence.
Options
Similar in nature to Futures though the buyer of an Option here is not obliged to honour his
side of the contract at maturity. As in Futures, Options is also a contract that two parties enter
into to buy/sell an asset on an agreed future date for the agreed price. Considering that, the
Buyer has no obligation to uphold his commitment at maturity; speculators may consider
Options as a tool to adjust prices of underlying assets. Terms such as “put option”, “call
option”, “strike price”, that are common in “Options” which I have tried to explain in below
example.
Consider an investor holding 1,000 shares of a certain stock at USD5.00 per share, who to
cover the risk of reduction in value purchases an Option at the cost of USD100.00. This “Put
Option” gives the investor the right to sell his 1,000 shares at USD5.00 per share – known as
the strike price - until the agreed future date. If the price fall to USD4.00 during validity of the
Put Option, Investor by selling is 1,000 shares at USD5.00 on maturity would have secured his
investment at cost USD100.00 paid when buying the put Option. If there were a rise in share
price at maturity of the Option, then the investor would have not benefited from the Option.
Now consider another investor who wish to purchase 1,000 shares each at its current price of
USD5.00, though wish to postpone the purchase in anticipation of a price rise. Here, the
investor buys a “Call Option” at the cost USD100.00 that will give him the right to purchase
1,000 shares at USD5.00 during the agreed validity of this call Option. If price rise to USD6.00
per share during the validity and if the Investor who is also purchaser of the call Option decides
to buy relevant shares at the strike price of USD5.00 per share, then he/she would have made
a profit is USD1,000.00 less USD100.00 the cost that incurred to buy the Call Option. A call
option itself will be meaningless, if prices drop below USD5.00 as the Investor then can buy
relevant shares at market pricing which is lower than USD5.00
As discussed above the seller of Options have to oblige with their undertaking when buyers of
options elect to exercise their right. Here, timing of buyers of Options exercising their rights
depend on the “style” of relevant Options. In an American Style Option – the holder can
exercise their right throughout the validity and expiration of the Option while in the European
style he/she will have wait until the maturity date. Generally, American style Options are for
stocks and exchange-traded funds and European-style options are for equity indexes including
the S&P 500.
(CFI, 2023) (FERNANDO, 2023) (cmcmarkets, 2023) (peakframeworks, 2023) (IG, 2023)
(Hub, 2023) (Digiconomist, 2014) (Elearnmarkets, 2023) (Charles Schwab, 2023)
Hedging Strategy of SC
Enter into Interest rate swaps to exchange assets and liabilities that are booked on floating rates
to fixed rates. This is to mitigate future cash flow variabilities. Similarly, to manage future
exchange risk variability on liabilities, assets and foreign currency costs, SC enter into currency
swaps and foreign exchange contracts. Operationally, it could be single transactions are
processed at customer level or on a portfolio basis for a group of clients.
SC’s Accounting Policy on Derivatives
Being a financial institution, SC as a policy categories derivative under trading and not as
hedging instruments if they are not specifically so designated. Derivatives are initially
recognized and thereafter revalues at Fair Value recognizing gain into P&L. Fair Value is
determined through various valuation techniques and from quoted market prices. Derivatives
are - in SC books – carried as assets when Fair Value is positive and liabilities when it becomes
negative.
In line with ERMF SC, identify products that required to entire into hedging with suitable
derivatives to manage risk associated with applicable Interest rates and/or underlying foreign
exchange. Such hedges should comply with ISA-39 (International Accounting Standard-
Financial Instruments: Recognition and Measurement) of 2003 and amendments to IFRS for
reforms on benchmark interest rate. Such hedges are classified under following three
categories.
3.2. Strategic Risk Management
Businesses have become extremely competitive so as increase in associated uncertainties and
threats in forms that are traditional and contemporary such as cybersecurity and climate. In
these environment, to protect and be successful businesses, having a robust strategic risk
management has become an essential within the architecture of organizations. Having a strong
and relevant strategic risk management not only help weather potential risks but also helps
identify and capture opportunities.
Racounteur, says that according to its leaders 85% of business operate in moderate to high-risk
environment and 79% of boards think to build value and protect their companies in the next 5
years, improved risk management is critical.
(Racounteur, 2022)
Strategic Risk associates with strategy that is set an organization for its future success. As
strategy of an organization is arrived at based on many decisions, strategic risk can be
considered as a collection of risks associated with decisions made. Having recognized Strategic
Risk, modern leaders of organization tend to use them as market indicators towards the capture
opportunities that are available. Here arises the requirement of managing Strategic Risk using
different strategies that is appropriate to nature of identified risk. Let’s now discuss five
common Strategic Risk Management approaches that leaders can contemplate.
Avoidance: As suggested the approach is to avoid risk completely. For instance, during
COVID-19, SC decided to avoid taking risk on certain identified sectors. It is rare that
organizations have the opportunity to completely avoid risk, though they must embrace it when
returns on capital employed elsewhere is more meaningful to the organization’s stability and
success.
Retention: As typically in banking risks are retained till such time that they are considered as
default. As a prudent approach risk are recognized and adequately provisioned for depending
up on the severity immediately upon them being identified, though impact of the same is taken
as a losses when it a default scenarios is established. As discussed sufficiently in the paper, SC
based on its strategy to downgrade risk profiles of identified clients during COVID-19, retained
relevant risks under different categories.
Spreading: As a policy banks approach large projects project a loans after forming a syndicate
with the aim to spread the risk amongst them. As a common practice banks also sell assets that
are already recorded in their books to efficiently manage risk. Managing risk here is in two
folds. First reduction in to reduce exposure and the second is to create capacity to do more with
its client. On the second aspect, banks a certain limit in terms of credit appetite of given client.
When a good client has fully utilized credit lines offered by banks, some of assets recorded
under this client is sold in the secondary market to create capacity so that new transaction with
better returns can be captured and the good client can be retained.
Loss Prevention and Reduction: Certain risks cannot be avoided. Idea here is to implement
measures that will prevent and/or reduce risk. WHF was an inevitable phenomenon during
COVID-19 and SC without delay made huge investment into cybersecurity and staff training.
The bank also updated its policies and procedures (thanks to ERMF) to ensure uninterrupted
service without compromising of IT security.
Transfer: As termed, idea is to transfer risk to someone who has the appetite for such risks.
Typically, insurance companies issue policies to cover risk of Buyers in international trade.
These are credit risk issuances that allow banks to finance international trade and facilitate the
cash flow process. Here, Insurance companies will assume the risk of the obligor. Similarly,
risks can also be transferred to developments banks such as European Bank for Reconstruction
and Development (EBRD), Asia Development Bank (ADB) and Export Credit Agencies
(ECA) like EKN that Swedish ECA and K-Sure the Korean ECA whose agenda is development
of economies and provide support to local exports.
Strategic Risk Management Framework
A framework that is equivalent to SC’s ERMF in terms of function. All information are
centralized with specific Key Performance Indicators to have adequate and timely response
from stockholders. Below diagram illustrate every step that is involved in putting together a
robust and workable framework.
(California State University, Fullerton, 2023) (Cascade, 2023)
SC’s approach to Strategic Risk Management during COVID 19.
Group’s Strategy and Strategic Risk Management committee that considering group’s foot
print, include Country Risk management of every country is responsible for the following.
Through impact analysis on the risk profile, identify and manage new risk or reprioritized
existing risk that are in line with group strategy. Vulnerabilities in business model, strategic
initiative and growth ambitions of the group are primary factors considered for this analysis.
Ensuring that approved risk appetite is in line with achieving strategic initiatives and growth
ambitions of the group and make recommendations for allocating additional risk appetite, for
Board’s consideration.
Validating the Five-year Corporates Plan prepared in line with group’s strategic review, ERMF
and GRAS is approved by the Board in conformity with Group Chief Risk Officer.
Country Risk management is mainly responsible for validating allocation of country wise limits
from group, country strategy perspective and operating environment perspective.
(Standard Chartered PLC, 2021)
4. Corporate Governance Best Practices
4.1. Corporate Governance
Corporate governance a system where rules, processes and practices are set with an aim to
direct and control organizations. It involves company’s Board of Directors and all stakeholder
including shareholders, clients, suppliers, lenders, regulators, governments and the community.
Board of Directors take the responsibility of setting up the framework with support from
advisors and intervention of shareholders. Good governance is an indications that the company
is accountable and well run to meet shareholder interests and expectations.
4.2. Principles of Good Corporate Governance (GCG)
4.3. Good Corporate Governance
Organizations are benefited from Good Corporate Governance as rules and processes build
around it gives the company a clear direction that is in alignment expectations of stakeholders.
Here, leadership is committed to introduce, improve and sustain adequate risk management
framework and lead by example to take responsibility for their actions. Good Corporate
Governance creates a work environment that has clear and transparent set of rules that everyone
an organization needs to abide by, that gives greater control which translates into results. As
these organization are transparent and prompt in publishing information they create greater
investor confidence. Here, investors and other stakeholder have a clear sense of organizations
direction and aspirations. In today’s world investors give greater preference towards companies
that included environmental and social (ESG) aspects to their Corporate Governance
framework.
Below diagram illustrates key elements of good governance that we applied across every aspect
within an organization.
Below illustration should attributes that an organization that has Good Corporate Governance
demonstrate.
Below diagram illustrate benefits that an organization can earn with good corporate
governance
4.4. Corporate Governance Best Practices
Good and effective corporate governance is important for the very existence and success of
organizations which also brings many benefits as shown above. To be at the top of their game,
protect the organization and to constantly improve to meet expectations of shareholders and
other stockholder, organizations adopt and follow corporate governance best practices. These
best practices are built corporate governance attributes discussed above and will broadly
address the following aspect.
• Having Board that is competent, honest and transparent
• Alignment with strategic ambitions
• Efficient risk management
• Demonstrate accountability
• Uncompromised integrity and high level of ethics
• Clear roles and responsibilities
A theme that always surface when discussing best practices is the work of the Board as we will
notice as we intend to move on discussing about some of mail corporate governance best
practices that are effective.
Appointing & Refreshing Directors to the Board.
Having a Board that is has the correct composition and relevant is key to good governance. As
a best practice, an organization must constantly evaluate the relevant of Board members in line
with evolving socioeconomic environments that impact the business and make changes to
representation to the Board. Board member recruiters need to fully understand each candidate
in terms of their experience, expertise, relevance, uniqueness and potential conflicts of interest.
Recruiters will have to be upfront and candid during the process and be have a mechanism that
will paint every candidate with a clear, honest, and exactly the same picture of the organization.
Even a standardized nomination process amongst recruiters with eliminate biasness during the
process. Candidates should be professionals and bring diversity to the boards, not just by
gender and ethnicity but also their age and tenure served as Board member.
Ensuring Effective Board Composition
Emphasizing on relevance of the Board, it is important the Board is of the right composition to
make adequate and relevant decisions. Boards will have to often deal with highly complex
situations and for the greater good of the organization has to make tough decisions. Here, the
Board must be objective and equipped with in terms of skills, diverse, and experience. An
important other element is trust and mutual respect amongst members to ensure productive
discussion even in most challenging subject with divided opinions. It is a view of most experts
in the field of governance that Boards should comprise of majority of Independent Directors
who should subject themselves to self-assessment to identify their strengths and weaknesses.
Director Orientation
Conduct a well-organized orientation to onboard new directors to the Board prior to new
Board’s first meeting. This could be informal as well, though preparation must include
presentations on company’s history, major accomplishments etc. There should also be a
welcome package including all aspects of the company including fiduciary & legal
responsibilities of directors and how to access company’s database to extract important
information like financial statements and strategic goals.
Nurture Presentation that are effective.
Functional leaders and directors must make presentations to the boards that are relevant,
accurate and complete in order for Board Members to concentrate on the subject matter rather
than seeking additional information that are required for decision making.
Align with company strategies and goals
The board needs to define and execute framework is in complete alignment with the
originations ambitions and short terms and long term risk strategies. Here, frameworks around
operational control, risk assessment, risk tolerance levels, other controls and monitoring need
to be put in place. Board should ensure a robust ERM is in place with proper roles and
responsibilities under its oversight and periodic review.
Ethics, Integrity and Accountability
One of the most important element and the Board should develop and implement strong internal
controls, monitoring and reporting frameworks. Board should instill within the origination a
culture where everyone feels accountable and demonstrate high level of integrity and ethical
behavior. Sufficient checks and balances need to be implemented. Should invest in reporting
systems that will provide accurate and immediate information. Publish internal codes on
conduct, ethical behaviors and conflict of interest. Reporting non-compliance and
whistleblowing should be integral part and board should introduce policies around them and
oversee implementation.
Define Responsibilities
Roles and responsibilities of every member of staff should be clearly defined through Job
Discerption and their objectives and KPI should also be clearly defined.
Producing Financial reports
Board should invest in timely preparing of accurate financial reports and publishing. Clear
regulations around this should be in place as it failing on any aspect of this has dire
consequences to the organization.
Effective communication with shareholders
The board should have clear, honest and regular communication with shareholder. Board
should have identified intervals set for such communications and along with a clear agenda.
Utilization of Technology
Responsible and efficient use of technology must be prompted by the directors. Necessary
investment must be sanctioned to make use of artificial intelligence where possible and around
related cybersecurity threats.
(slideserve, 2014) (Peterdy, 2023) (CHEN, 2023) (Olivia, 2022) (Farnham, 2023) (McDonald,
2023)
4.5. Roles and Responsibilities of Audit Committee in Managing Ethical Issues
This is a committee that is a sub-section on the Board of Directors whose responsibility is to
oversee financial disclosure and reporting. In mature organizations this committee administer
internal control, compliance ethics in addition to financial reporting and related risks. The
committee coordinate with management teams, internal and external auditors to ensure
compliance with internal policies, procedures and law & regulations. Most companies have
their audit committees responsible for overseeing code of conduct and the way in which they
are implemented. Accordingly issued related to ethics naturally fall under the responsibility of
audit committees.
Taking note that NYSE-listed companies need to have their audit committees overseeing legal
and regulatory compliance, boards of companies have considered the audit committee
overseeing ethics and compliance.
Ethics and Code of Conduct
This is an important document that details do and don’ts for employees, managers and officers
in an organization that needs to be embraced to establish ethics and compliance within the
organization. Rules defined by SEC on ethics are design to promote the following aspects.
Companies are expected to include above in their annual reports as disclosures and make a
copy of their code of ethics available to public. There should be enforcement of the code in a
consistent manner and providing protection to reporting individuals.
Audit committee who are responsible for overseeing compliance and ethics must put together
the code of ethics in coordination with the management determine and make necessary update
from time to time as and when required. It is also import that the documents reaches all
employees who must read and ahead to provisions therein. As a best practice there could be an
annual declaration signed by all employees confirming that they have read and understood
provision in the code of ethics. Communication to employees must also emphasis on the fact
that violators will be subject to disciplinary actions depending on the severity of the breach.
Different way to report violations should be set and staff must be encouraged to report without
fear. The audit committee with the management must ensure that complained have reached the
appropriate members of management and they are aware of complaints received from internal
and external sources including vendors, and third parties etc. through available reporting
methods. Responsibilities of respective managers is to investigate and report back to the Audit
Committee for them to recommend and take necessary disciplinary action or further investigate
as appropriately.
(CFI, 2023) (Deloitte, 2018)
5. Risk Modelling
Risk modelling is known to be tool that organizations have used to calculate risk and has been
an integral part of business for many years. With the increase in complexity, enhanced risk
environment and availability of data with advanced analytical tools, organizations have started
to use a wide range of such models and for addressing all types of risks including strategic,
financial, operational, ESG and compliance.
Dr. Patchin Curtis, Director at Deloitte & Touche LLP and leader of Deloitte’s Center for Risk
Modelling and Simulation says that through enhanced technology is available to advanced data
analyzing, information that is extracted are based on historical events which might not be
relevance to dynamics of the future. Though information here will be helpful to address risks
that companies have seen in the past they may not provide sound forecast of the future where
dynamics are ever evolving. Testimony is to this is the collapse of Silicon Valley Bank, Silicon
Valley’s largest bank by deposits, in a few days as they were not prepared to survive in a risking
interest rate environment. This is where risk modelling becomes a tool to recon with as it
include data analytics and other relevant factors to facilitate decision-making.
Risk models is a mathematical illustration based on probability distributions. Here, data
collection is a vital part as it involved views of industry experts to establish probability of
occurrence and severity to present a meaningful model that is convincing to decision-makers.
Organizations apply these models for each specific risk that require to evaluated as information
that required to be gathers will rather be specific than general. A good risk model when
developed will be applied in normal circumstances as well as perceived stress scenarios to
understand organization’s tolerance levels. In order for these Risk models be meaningful to the
organizations overall architecture, once developed they must become part of companies ERM
frameworks.
From various Risk Modelling techniques let us discusses challenges that organizations face
when applying two identified techniques.
5.1. Value at Risk (VaR) Modelling
Concept here is to determine the element that could potentially incur a loss and the probability
of such loss materializing measured at an identified level of confidence. Parameters considered
in calculating VaR are the amount of potential loss, probability of it happing and the determined
timeframe. As discussed earlier, the model can be applied for every specific or at an enterprise
level after aggregating the results of different aspects.
VaR Modelling can follow three different methodologies
Historical Method – Here company returns of previous years are lined-up according their
performance from worst year to best year. Principle here is that past experiences will guide in
addressing future outcome.
Variance-Covariance Method - Concept here is the possibility to plot potential losses as
standard deviation items from the mean. As this concept is similar to that of identifying risk,
the approach is most suited for risk management. Result may be less dependable for assessment
with smaller sample sizes.
Monte Carlo Analysis Method – As discussed the concept associated with the method
elsewhere in this paper a range of outcomes are plotted to identify the impact. This method can
be used for assessing a wide range of risks and based its assessment on the understanding that
probability distribution is known for the identified risk factor.
Benefits of using VaR
• Easy to comprehend as it is a single number that is derived from various elements that
summaries the impact.
• Usage on a wide range of items including different assets classes, products, projects and
even at a portfolio level.
• Widely used, that gives the ease of presenting results to a wider audience.
Challenges in using VaR
• Quality of output will be based in quality, relevance and accuracy of data considered for
VaR.
• Considering that there is no standard practice prescribed, manipulating the final outcome
to be in line with expectations is possible.
• Possibility to give a false sense of protection; with confidence level less than 100%.
• Considering 99% confidence also mean that there is possibility of the 1% from happening
and VaR does not consider this risk which potentially can be higher than the High VaR that
is reported. Thus, extreme events may escape from being detected.
• As VaR is reported in a single number, it only represent the lowest point in the outcomes
scale, and not those other points within the identified range that could still cause
risks/losses.
• Unable to provide a long terms view (more than 10 days).
(Deloitte, 2023) (KENTON, 2023) (Educate 360, 2023)
5.2. Potential Future Exposure
Typically used by banks to measure counterparty risk. Concept here is to establish the potential
future exposure to be the worst exposure an organization could have at an identified future
time, measured at specific confidence level. Time horizon here is determined by the identified
project and/or transaction while confidence level is determined at an organizational level. To
explain with an example, consider a bank 10-month PFE of USD 20 Million calculated at
97.5% confidence. This will translate into the bank being 97.5% confident that in the 10 months
into the future it from its portfolio of exposure will not incur loses that is more that USD 20
Million.
Modelling PFE
Simple method of PFE modelling is to apply conservative scaling factors to current value of
identified items. More advanced approach involves Monte Carlo Analysis where factors that
impact future portfolio values are plotted to establish future exposure distribution. This model
expects to address diversification and concentration risks. Having already discuss Monte Carlo
analysis and its interpretation, the following components will have to be identified and selected
to conduct the meaningful modelling.
• Key factors that drive portfolio exposure, and
• Evolution of these factors with time
Challenges in using PFR
• Drawbacks in the method is that it does not consider future events that could have an impact
on exposures.
• The model does not highlight presence of concentration risk at a portfolio level.
• With confidence level less than 100%, may give a false sense of protection.
• Not effective to provide short terms view.
(Tudela, 2022) (ANALYST PREP, 2023) (Finance Trainig Course, 2016)
5.3. Risk Modelling used by Standard Chartered Bank
SC use VaR model to measure market risk where losses from potential adverse movement in
market rates, prices and volatilities are measured. VaR is applied across products and trading
businesses of the bank. Group use Historical and Monte Carlo simulation methods.
Counterparty credit risk, the group use PFE model. Both models are applied on a day-to-day
basis with 97.5% confidence level.
Below extract show significant increase in average VaR driven by extreme market condition
as a consequence of COVID-19 and other associated factors such as collapse in oil prices.
(Standard Chartered PLC, 2021)
5.4. Markowitz Efficient Frontier and Modern Portfolio Theory
Modern Portfolio Theory (MPT) is a theory where investors gather a portfolio of assets with
the aim to maximize returns for the level of risk taken. The theory assumes that an investors
are always risk averse and argues that they should be compensated with higher returns when
they take higher levels of risk. The theory is also based on the idea that it is less risky when
investing in assets from different classes as against from the similar types.
Nobel Laureate Harry Markowitz introduced the Efficient Frontier Theory (EFT) in 1952
which is considered as the foundation of MPT. By plotting investments (portfolios) on one
scale and returns on the other EFT is expected to provide a graphic representation of portfolios
that maximize returns for the risk assumed.
Let’s discuss Efficient Frontier Theory (EFT) with the help of below illustration, which reflect
a typical Efficient Frontier. Here, let’s consider efficient frontier (also portfolio frontier) as set
of portfolios and plot expected returns in Y axis while plotting change in risk (standard
deviation) on X axis.
Expected Return – Possible return that efficient frontier can provide to the investor.
Assuming efficient frontier contains portfolio of assets ASSET P with investment of USD
7,000 that gives a return of 10% and ASSET Q with investments of USD 2,000.00 with return
of 5%.
Here, Expected Return = [(7,000/9,000) * 10%] + [(2,000/9,000) * 5%] = 8.89%
Standard Deviation – Measure the level of volatility of an asset. In other words this represent
the risk element as wider the spread of standard deviation higher the risk factor is. Here,
standard deviation at portfolio level rely every asset in theta portfolio, their weight and
correlation between them.
Risk-Free Rate – This represent expected rate of return in an asset that is with NO risk. In
reality this assets that have low default risk and fixed returns can be considered under this.
Efficient Frontier – represent the upper part of the curve that starts from Point A and shows
all assets that are risky and expected to maximize return for a given level of risk represented
by standard deviation.
• Point “A” – portfolio that contain minimum risky-assets at lowest risk levels.
• Point “B” – this is the optimal market portfolio that include one risk-free asset, at least.
Capital Allocation Line (CAL) – the line that show the balance between risk and reward of
assets that have idiosyncratic (distinct) risk. The slope (Sharpe ratio) represent the increase in
expected return with every additional unit of standard deviation (reward to risk ratios).
In the above illustration reward to risk ratios is at its highest at Point B and has the optimal
portfolio as per MPT. This is also called market portfolio while MTF suggests that risk-averse
investors who are also ration should consider investing in portfolio that will be on the Efficient
Frontier as the same will provide highest possible return for the level of risk taken.
(CFI, 2023) (GANTI, 2023)
5.5. Capital Asset Pricing Model (CAPM)
CAPM explains the relationship between systematic risk of investing and expected returns
against them. This finance model shows the linear relationship between expected return and
associated risk. The module is based on relationship between the risk free rate, as asset’s Beta
and the risk equity premium which the difference between expected returns and the risk free
rate.
Risk Free Rate – This is typically the rate is the equivalent to the return on 10 year US
government bond. Though country of investment and the maturity are elements that should
reflect in the risk free rate, for agreement amongst professionals is to use the 10 year rate,
irrespective as it is the most quoted and most liquid bond.
Beta (β) - is a reflections of a measure between price volatility of securities and the overall
market (usually the S&P 500). Stocks that have Beta greater that 1.0 are considered more
volatile when compared with S&P 500. Securities that have a positive Beta number has a
positive correlations with the market and vice-versa.
Market Risk Premium – In simple terms this is the difference between expected returns and
the risk free rate. This is the compensation that investors get for investing in riskier assets which
is over and above the risk free rate. Market risk premium is higher in a market that is more
volatile.
Consider a stock that is valued today at USD 10 per share and pays 3% annual dividend. Beta
compared with the market for this stock is 1.3; and risk free rate is 3% and investor expectation
is for the market to rise annually in value by 8%.
ERi = 3% + 1.3 x (8% - 3%)
Expected Return of the stock as per CAPM is 9.5%
CAPM formula is criticized for it being based on assumptions that are far from reality.
Considering below are two major assumptions that modern financial theories are based on,
relevance of CAPM has become questionable.
• Competitiveness and efficiency of securities market and speed of information sharing
• Dominance of risk-averse investors in these markets who are rational and the want to
maximum returns against the level of risk taken.
Further studies involving various stock exchanges in the USA, it is established that Beta over
a long time period failed to explain performance of different stocks. These studies also showed
that disruptions in linear relationship amongst returns on individual stocks and Beta over the
shorter term. These results raise the question of accuracy of Beta that make CAPM’s
calculations incorrect.
Using 10 year risk free rate is also questionable as it is noticed that over the last 10 year US
Treasury Bond prices have not remained at the same level and have seen significant increase.
Calculation of Market Risk Premium is based on an estimated value which also pollute CAPM
results.
When investor use CAPM to perfectly optimize returns against relative risk, then that would
be under an Efficient Frontier curve as shown hereunder.
(KENTON, 2022) (CFI, 2023) (KENTON, 2023)
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