Reinventing RI companies risk management

Reinventing RI companies risk management

David O'Brien, Jakarta

I read with interest David Finneren's article Assessing
business performance in The Jakarta Post of July 11, 2005. The
benefits of triple bottom line reporting in the developed world
are still being debated with many believing it is better managed
through the overall risk management of the organization. In the
Indonesian context I believe there remain a few more "baby steps"
to go before stretching so far.

The key point I noted from the article was the fact that "the
top quartile of JSX (Jakarta stock exchange) firms possessing
good governance ratings enjoyed an average share price out-
performance of over 200 percent". I am not clear how many
companies possessed good governance ratings and subsequently what
made up the top quartile but the message is clear. Those
companies with best practice governance outperformed the market.

It still begs the question, what is good governance? It seems
to be the term, along with legal/regulatory reform and direct
foreign investment, which is most readily promoted as the cure to
Indonesian economic ills. How will it do that?

One view is that it can best be considered in light of a
framework of enterprise wide risk management (ERM) rather than in
isolation. ERM is a process for empowering managers so that
those closest to the risk take accountability for it under the
overall governance framework of the organization.

The importance is accountability rather than elimination of
risk. A basic business precept is the relationship between risk
and return. More risk the greater the return and vice versa. A
balance must be reached between the two which is the governance
framework senior management has responsibility for.

The board has responsibility for setting the overall attitude
of the business to risk and this will embed itself in the culture
of an organization. At Enron you had a "cowboy culture" that
embraced and rewarded consistent short term out performance.
Later failures in internal controls to highlight the gaming that
was occurring in quarterly reporting through off balance sheet
vehicles was a consequence of the risk attitude.

A similar attitude seems to have been prevalent in many
Indonesian firms prior to the economic crisis and even more
recently. The current rash of corruption cases and the backlog
of others is evidence of such. When there is malfeasance at the
top of the organization and the approach suggests this is
appropriate culture, managers and staff down the line will simply
fall in with the example set. This is a perception that has
stuck in the mind of capital markets and continues to hamper
investment in Indonesia.

There is now a shift by the government from privatization to
extracting a return from BUMN (state owned enterprises) in the
form of dividend. This is a marked shift from the former
privatization programs earlier instigated at the urging of multi
lateral agencies. There seems to be an attitude that the
efficiency gains available via restructuring of agencies can be
retained by the state.

To ensure this is a success the government will require that
the BUMN run as world best practice businesses to earn an
appropriate return on state funds invested in these enterprises.
If historical practices of leakages via corrupt business
practices continue unabated this will not be possible. In
addition such businesses will not meet requirements of the
international capital markets, whose support is required to meet
the levels of growth required in a rapidly improving economy.

Development of ERM results in ownership of business processes
and accountability at all levels throughout the organization.
Senior management are accountable for setting the overall
governance framework and attitude to risk. They remain
accountable to ensure that these risks are ascertained and
managed with contingency plans; mitigated via transfer to third
parties or shift in business processes; or managed through
appropriate level of controls.

The process of identifying risks is usually taken via a
process known as Controls Self Assessment (CSA). This is
commonly a facilitated approach whereby business processes are
mapped through the organization. Risks are subsequently
identified and quantified across these business processes. An
overall risk register will be developed which allocates
responsibilities for specific managers to manage their risks.

Such an approach is to promote the end result whereby risk
assessment becomes embedded at all levels of the organization and
not another business silo viewed as extra bureaucracy to perform
a job. The empowerment and allocating of responsibility to line
managers should act to instill an approach that leads to an
improvement in business performance. This will especially be the
case when these accountabilities are linked to performance
measures and subsequent rewards.

We believe ERM will become the industry standard for risk
management. ERM will continue to gain acceptance as the best way
to ensure that a firm's internal and external resources work
efficiently and effectively in optimizing its risk/return
profile. New financial disasters will continue to highlight the
pitfalls of the traditional "silo" approach to risk management.
External stakeholders will continue to hold the board of
directors and senior management responsible for risk oversight
and demand an increasing level of risk transparency.

More importantly, leaders in ERM will continue to produce more
consistent business results over various economic cycles and
weather market stresses better than their competitors. Their
successes will gain attention and other companies will follow.
These trends, coupled with a stock market that is increasingly
unforgiving of negative earnings surprises, will compel
businesses in all industries to adopt a much more integrated
approach to measuring and managing enterprise-wide risks.

The Indonesian capital markets oversight board (BAPEPAM) has
already mandated via decree in late 2004 that the responsibility
of an audit committee is not confined only to the area of
finance, accounting and compliance issues but broader risk
management. In addition there are specific Indonesian
organizations with instruments listed in U.S. which are
experiencing the onerous requirements of Sarbanes Oxley.

At the end of the day the approach is all about lowering
Indonesian businesses cost of capital to allow for growth. Such
an approach to risk management will help to satisfy capital
markets that change is being implemented at the micro level. A
well developed and educated investor relations arm can further
aid in educating capital markets locally and abroad of the
advances being made in such an area.

Businesses can wait for laws to be passed, be pushed into
doing something or embrace the opportunity. Employees can be
empowered and transparency enhanced which will reduce the power
of established forces against change. Such vibrant state and
privately owned firms will act as a beacon for international
capital and enhance Indonesian growth more effectively than a
procession of corruption cases.

The writer is a Technical Advisor at CSA Strategic Advisory.
CSA helps businesses through a combination of "soft" behavioral
and "hard" financial advice. He can be reached at
dobrien@csadvisory.com.