Integrated Risk Management Software for non-financial Corporates, Insurance and Governments

Transcription

1 Integrated Risk Management Software for non-financial Corporates, Insurance and Governments An extension of the applications of riskpro TM the integrated financial analysis infrastructure from IRIS integrated risk management AG Contacts: Dr Daniel Imfeld Dr Willi Brammertz RFM IRIS AG Risk and Finance Management Dufourstr 80 Business Partner of IRIS AG CH-8034 Zürich Switzerland phone: 41 (0) phone: 41 (0)

2 Background: IRIS AG is a Swiss Software company employing about 60 highly qualified specialists in Economics, Mathematics, Physics and Software Engineering in Switzerland, with branches in Zürich and Lausanne. Since 1992 Iris AG is focussing on the development and introduction of its integrated financial analysis software for banks, called riskpro (risk and profitability analysis). The riskpro solution has won the 1999 innovation price of the Technologie Standort Schweiz Stiftung (Technology Foundation in Switzerland). Today riskpro is implemented within more than 200 financial institutions in 15 countries worldwide. With riskpro IRIS AG has developed a unique methodological approach allowing integrated modelling and simulation of any kind of risk impact (like foreign exchange or interest rate, stock and commodity price risk, credit risk and operational risks) on cash flows, earnings and value over time within banks. The unique method allows expanding riskpro to new applications meeting the integrated risk management needs in non-financial Corporates, Insurance and Governments. IRIS AG has launched the initiative to enhance riskpro to satisfy also the risk and financial analysis requirements of these organizations. Based on integrated cash flow simulation including the key risk and value drivers of an organization riskpro is enabling clients to address the following risk management and financing issues: Optimising the capital structure that supports the overall risk profile of the corporation Allowing the design of hedging, insurance and risk financing policies that create value Saving expenses on unnecessary hedging/insurance Supporting quantification and pricing of credit risk (default of clients) Corporate budgeting under uncertainty. Introducing risk considerations in terms of costs, revenues, investments and financing into the budgeting process Measuring performance (Earnings, Cash Flow, Value) on a risk adjusted basis Assuring the compliance of accounting and regulator standards Supporting pricing of large new business opportunities in respect of risk loadings/discounts for incremental change of the overall risk profile due to new deals. Explicit pricing of financial risks and/or options that are built into core business products (long term contracts with fixed prices, vendor financing, guarantees, etc) Assessing overall risk diversification and risk accumulation for different business scenarios including M&A scenarios. Supporting design of new risk financing solutions (insurance, ART, derivatives, contingent capital or combinations).

3 Correspondingly riskpro will find many applications in different corporate functions like corporate risk management, treasury, credit risk management, marketing, corporate planning, M&A evaluation, regulatory compliance, accounting (IFRS 39 or FAS 133). The integrated approach of riskpro which is linked to a common data and calculation repository for all concerned applications can save a lot of time and costs in the area of financial and risk analysis as well as reporting. It will also contribute to an enterprise wide common language and denominator in risk, profitability and value measurement. New applications for riskpro with non-financial Corporates, Insurers and Governments After a period of experiments and new developments during the 1990s the approach of integrated risk management (IRM or Enterprise wide risk management ERM) is gaining more and more acceptance worldwide within the segments of non-financial Corporates, insurance companies and even governments. In contrast to the banking sector however, there are no common standards yet neither in the area of IRM approaches nor in the area of software products supporting such an integrated corporate risk management as a basis of a financially oriented value management. Most companies outside of the banking industry rely for their IRM analysis still on large excel models in combination with some sort of statistical software or crystal ball. This approach however does not meet the requirements and the necessary degree of sophistication of large organisations with long product cycles, commodity price dependencies, subsidiaries worldwide, etc. In addition such an excel based approach is costly and risky in many respects: risk of inappropriate modelling in the non-core business risk area where know-how is lacking (typically market risks or credit risk for non-financial Corporates) high model risks stemming from large excel based models that can not be audited high people risk since a few experts have built and run the model high reconciliation efforts and cost risk of bad documentation and loss of the model when the experts leave the company

4 Different RM needs: long term perspective with focus on Cash Flow and Earnings The needs of non-financial Corporates, insurers or governments with regard to corporate risk management are clearly different compared to the classical banking needs. Banks focused for a long period on short term market risk (a few days to a couple of weeks) on the valuation of a portfolio of financial instruments (VaR approach). Now the awareness of the importance of the going concern and the credit risk is finally taking off, partially triggered by the Basel II agenda. Non-financial Corporates and insurers need to take a longer term perspective of one to three and more years depending on their investment and business cycle (for example Pharma R&D cycles take up to 5-8 years and payout patterns from liability insurance losses often take more than five years.) In addition the risk management focus of non-banking Corporations is much more on Cash Flow and Earnings. As a consequence the classical banking approaches of Value at Risk are of very limited use, often even misleading. However, also banks have been working not only with VaR techniques, but also with income forecasting over time and cash flow simulations. These techniques have been developed in the early 80's and have been used ever since then - though overshadowed by VaR in recent years. Within the riskpro platform for banks the cash flow simulation technique was included from the beginning and they have now reached within riskpro a very sophisticated and dominant level. The cash flow simulation approach is today also spreading into risk management departments in other industries and this trend lays the ground for new applications of riskpro. Dynamic Cash Flow Simulation: starting point for RM under going concern There seems to arise a consensus in finance research as well as among RM practitioners that the corporate risk management of companies (non-financial or financial) under going concern should be based on a dynamic and integrated cash flow and risk simulation over time. 1 Concepts like Earnings or Cash Flow at Risk require in essence such an integrated risk and value simulation of a corporation starting on the level of cash flow. This consensus is supported by the increasing focus on value oriented management. 1 Also banks are more and more switching to such an approach which is already integrated in the riskpro banking solution. For references please contact us.

5 From a finance oriented approach to corporate risk management it becomes also obvious, that for investors (and to a large extent also for managers) it is ultimately irrelevant which source of risk or risk combinations (market, core business, credit or operational) might cause a cash flow shortfall or a constraint in financing or investment. All risk and value drivers need to be understood in their impact on future expected cash flows and/or on the corporation s overall risk profile determining its cost of capital. Risk correlations or risk diversification potential needs to be taken into account. Differentiation between diversifiable and systemic risk may lead to differing conclusions on risk management strategies. Starting risk management analysis on the basis of a cash flow simulation still allows differing views from an accounting, tax or regulatory perspectives. Riskpro will allow deriving those views from the basic cash flow perspective by overlaying different accounting regimes like IFRS or US-Gaap, statutory accounting rules, solvency regulation or Basle II regulation. The common accounting regimes and regulatory requirements are already built into the existing plattform. riskpro meets already basic needs of non-financial Corporate risk management The needs and new trends in corporate risk management create a lot of opportunities for increasing the scope of new applications of the existing riskpro plattform. The concept of integrated risk management based on dynamic risk and cash flow simulation for a corporation was already implemented as a core building bloc in the first version of riskpro. Thanks to the fact that riskpro takes advantage of a unique methodological approach that focuses first on economic realities (cash flow patterns) the riskpro platform can be extended to new applications in other industries. Riskpro is designed to simulate any kind of economic activity or risk that can be described in a cash flow pattern over time. Differing reporting structures, accounting regimes like IFRS or US-GAAP and regulatory requirements are then derived from the basic cash flow perspective.

6 IRIS AG and RFM are in the process of developing three new templates based on the existing riskpro architecture: one each for non-financial Corporates, insurers and governments. This will of course require certain adjustments and enhancements; however already in the existing riskpro platform we are able to model a large portion of risks from a typical non-financial corporate risk landscape, including certain core business risks. At this stage the existing riskpro platform will allow for non-financial Corporates to model market, credit and commodity price risks as well as insurable types of risks like long term liability losses or property losses. Hence the existing platform will allow already a wide ranging integration of financial and insurable risks. Specific extensions and adjustments may become necessary for core business risks A wide range of core business risks of non-financial Corporates, insurers (like product price risks or volume risks) and governments can already be implemented into the existing platform. Specific extensions for core business risks (loss of key customer, business cycle dynamics) or operational risks may need some extra adjustments. These we evaluate and develop in cooperation with clients as industrial partners. At the moment we model those risks based on prototype modelling. Prototype modelling means that we will define with a client the modelling requirements and test, to what extent the riskpro plattform would need industry specific adjustments. The adjustments are then first modelled in a prototype version before they are actually written in the riskpro software. Clearly the further development of the three templates for non-financial Corporates, insurers and governments will require systematic and in depths analysis together with interested industry partners. A performing future oriented integrated risk management infrastructure can not be built without direct exchanges between the ultimate users and the software developer.

7 A road map to implementing a prototype version of riskpro for non-banking clients 1. Discussing client s risk management and risk landscape approach and defining requirements for an integrated risk management software solution from the perspective of the industrial partner. (degree of integration required across risk classes) 2. Priority Templates are: a. A) non-financial Corporates, b. B) Insurance c. C) Governments 3. Priority industries within template groups a. A) Energy, Telecom/Technology, Pharma worldwide b. B) Life, Non-life insurance and Group Captives from industrial clients (this will create high synergies to A) allowing integration of insurable risks c. C) Government bodies and public entities 4. Modelling of all financial market risks like foreign exchange, interest, commodity prices, liquidity which are already covered as standard within the existing riskpro plattform 5. Modelling Credit Risk (default of clients and key suppliers) in the existing plattform 6. Modelling and pricing of financial risks embedded in core business products (implied options, fixed price arrangements, vendor finance agreements, guarantees etc) in existing riskpro platform. 7. Defining typical additional risk factors to be included beyond item 4-6: partly in the existing plattform, partly based on prototype modelling. a. Core business risks like: R&D, core business pricing, loss of key clients, industry cycles etc. b. Fixed Asset investments in production plants, aquisitions etc. c. Insurable risks: product liability, D&O, patent infringement, business interruption, operational risks like ITC-related risks including payout pattern analysis for long tail business. d. Inventory related or supply-chain-risks

8 e. Political risks f. Weather risk g. Tax income and financing of government services investments h. Other risk factors 8. Including all risks as defined above in the context of a concrete model of the client s institution and financials in the form of a prototype version. a. Statistical quantification b. Institutional Model of the client c. Modelling of risk dependencies d. Strategy and Management Targets e. Dynamic cash flow and risk simulation 9. Gap analysis of prototype version compared to client s requirements. Conclusions on the need of further enhancements of the industry specific template. 10. Design and implementation of the industry specific template with adjustments where necessary. For interested clients we usually offer a phase zero test implementation of the riskpro analysis infrastructure for an agreed period. In the context of the project the use of the software is free of charge for that period, during which we define a first pilot modelling phase in a project team with members from the client and IRIS AG / RFM. The services in the pilot project include training and basic modelling of the client s risk landscape and are usually based on a fixed price arrangement depending on the size of the project, and the allocated resources of each party.