Section 8 Risk factors and approach to risk management

Transcription

1 Section 8 Risk factors and approach to risk management

2 GENERAL Risk management practice standards are the responsibility of each business unit manager throughout the organisation. AWB has recently appointed a new Chief Risk Officer to facilitate best practice corporate governance including business risk attribute identification, monitoring and reporting. There is a clear separation of duties between operational risk management units that execute risk strategies and monitoring and reporting system responsibilities. ORGANISATIONAL STRUCTURE FOR REVIEWING RISK The Board has two committees devoted to monitoring risk factors and ensuring compliance with Board policies and delegations, those being the Audit Committee and Corporate Risk Board Committee. The Audit Committee is responsible for reviewing internal audit report outcomes with respect to compliance with approved policies and procedures, as well as through comparison with best practice risk management activity. It also reviews all operational risk matters raised by management. It seeks to ensure that accounting policies and practices are appropriate, that financial statements reflect a true and fair position, proper internal controls exist, and policies and procedures comply with statutory and legal, financial and corporate governance responsibilities. The Corporate Risk Board Committee s responsibility is to seek to ensure that financial exposures, including interest rate, currency, commodity, credit and freight have a sufficient policy and a strategic direction framework in place and that these are followed. Such activity entails determining the markets in which AWB can transact, the financial instruments AWB can utilise in managing risk, and the appropriate level of delegation that operates in the risk management environment. These are then recommended to the Board for approval. In addition to the two Board Committees, an executive Corporate Risk Review Committee, which meets weekly (or more often if required), has been established to review and approve the formulation of risk management strategies, monitor compliance with delegated authorities and provide a forum in which operational issues can be raised and discussed with senior management. The Corporate Risk Unit, managed by the Chief Risk Officer, is responsible for reporting to the above Board Committees and also the executive management committee. A trade finance team manages credit risk. This team reports to a management Credit Committee in a similar manner in which other risk reporting occurs to the Corporate Risk Review Committee. MARKET RISK MANAGEMENT Market risk management activity occurs in four primary areas within AWB, being Pool Management Services, Funding and Underwriting, Grain Acquisition and Trading and Chartering. Separate Board policies dictate risk management requirements for each of these businesses. National Pool risk management is performed for AWBI while all remaining business is that of AWB. Market risk factors include grain futures price risk, grains basis price risk, foreign exchange risk, interest rate risk and ship chartering price risk. Most of these risk types also allow for the use of options contracts, which increase the respective market risk profile complexity. Market risk guidelines are determined after giving consideration to historical futures, flat and basis price volatilities, market liquidity factors, pricing curve spread performance, geographical price spread movements, physical versus hedge mechanism price correlations, transaction timing capabilities, grade differentials, etc. Other important aspects in grain price risk management include freight spreads, logistical constraints in handling large quantities of physical, perishable commodities and also politically motivated price subsidies from overseas governments. Capital at risk guidelines are provided by the Board. These are then transformed and delegated down to the risk management areas through a number of different limit types, generally expressed in outright and basis tonnage allowances, maximum open interest futures holding levels, net US dollar open position allowances, net notional dollar exposure levels, etc. Chartering price exposure limits also consider exposure levels to time chartering and also voyage chartering contracts. GENERAL BUSINESS RISK MANAGEMENT A number of additional risk factors inherent within AWB s business activity are discussed below. Crop size Financial returns to both AWB and the National Pool can be directly affected by the size of the annual wheat crop. This volume risk affects areas such as the pool management fee, interest rate lending returns, underwriting fees, margins in grain acquisition and trading, chartering throughput, etc. In order to manage that risk, AWB has in place a detailed methodology to forecast upcoming wheat crop output, including analysis of soil moisture levels, total hectares 90 Section 8: Risk factors and approach to risk management

3 planted, crop weather patterns, yield expectations and the like in order to adjust AWB s wheat risk management activity in a pro-active manner. Added to this are continual informational analyses on world supply and demand factors to assist AWB in shaping and planning future sales execution and logistics strategies for physical crop risk management. Examination of non-wheat market activity to offset this risk is also under consideration and development. International market competition and government subsidies As one of the world s largest wheat exporters, AWB faces global competition from grain sourced from a number of countries, including the US, Canada, Argentina and the EU. Additionally from time to time opportunistic producers, such as India, Ukraine and Turkey can enter AWB markets. Given these factors, the magnitude and type of competition faced by AWB in international markets can vary from year to year. In order to improve AWB s knowledge of the global market and to reduce the risks of competition, AWB monitors the supply and demand fundamentals of world grain production and use. This activity, undertaken by the Market Analysis Group in conjunction with International Sales and Marketing Account Managers, includes monitoring at a country level of wheat production, quality profiles and import and export demand. This information supports AWB in the marketing of grain to its customers through improved market intelligence, and assists to reduce the risks associated with changes in international markets. In addition to the risks associated with the supply and demand fundamentals of AWB s competitors, government subsidies have an effect on AWB s ability to compete in many markets by distorting market forces. For example in the US, there have been a number of policies initiated under the Federal Agricultural Improvement and Reform Act 1996, an act which is intended to provide a safety net for US farmers through the support of farm incomes. The major provision of the Act that affects AWB is the GSM Export Credit Program, which provide US Government backed bank loans at commercial interest rates for eligible buyers of US wheat. A second example is the EU, which has a centrally controlled agricultural policy through the Common Agricultural Policy program. This program arguably distorts global wheat supply by creating excess stocks that are exported from the EU at less than market value. AWB closely monitors the actions of government subsidies and support programs and in conjunction with the Australian Government and industry, actively lobbies against trade distorting practices by competitors. Underwriting AWB provides an underwriting facility guaranteeing a percentage of estimated net pool return. AWB is subject to the risk that the final net pool return ultimately realised is below the estimated net pool return and that, as a result, it is called upon to make up the difference with growers who have taken out the underwriting option. Residual risk for this facility is borne by AWB and is the product of the entire market risk management process described above. It is continually monitored by the Corporate Risk Unit and formally reported weekly. In order to gain assurance on risk levels, AWB uses independent actuaries in the quantification of that risk. Should additional management or mitigation of underwriting risk, in addition to that already in place, be considered necessary, then such recommendations are put to the management committee. Additional risk management options could include alternative risk transfer mechanisms, specific hedging of selective risks using derivatives, reinsurance or undertaking cash market activity. Chartering Chartering s primary objective is to provide a cost effective service to the National Pool. In order to do that, AWB needs to manage various risks. Risks inherent in AWB s chartering activities include contract execution, exposure to market fluctuations, core capability and time charter price risk. These are covered in turn below: Contract execution This involves having adequate administration in place to ensure that the financial outcome of any trade is captured fully. Poor contract execution can result in substantial leakage of profit. Chartering is structured so as to minimise the risk of poor contract execution. Exposure to market fluctuations Chartering will only be financially exposed to price movement in the freight market when it chooses to hold a long or short freight position. AWB chartering monitors its freight position daily and reports weekly to the Corporate Risk Review Committee. Chartering has strict exposure limits that it must observe. Core capability Chartering is a complex business with many terms and conditions of trade. As such it is important that chartering is structured appropriately and employs individuals with adequate core capabilities to protect the capital at risk. Chartering was restructured in February 2001 to better reflect the growth opportunities and all positions within the structure are now filled with employees equipped with the necessary core capabilities. Section 8: Risk factors and approach to risk management 91

4 Time charter price risk Taking a vessel on time charter is best described as a leasing arrangement. There are two major risks involved in such a venture. The first is that the freight market falls after taking the vessel on time charter, thereby reducing the ability to utilise the vessel profitably on voyages. The second risk is in relation to active employment of the time charter vessel. Time charters are traded on a US$/day basis, so that if the vessel is not being used to carry cargo it is not earning any income despite paying a daily hire rate. The time charter exposure is managed daily within Company set limits and is reported weekly to the Corporate Risk Review Committee. Time charter vessels are an important component of the chartering activities. The success of the time charter program hinges on chartering having the volume to support this activity, securing cargo for the vessel and operating the vessel efficiently. Insurance AWB relies predominantly on bulk handling companies to store and handle grain for international sale. Because of this, it arranges and manages, as a cost effective measure, joint insurance policies with those bulk handlers, as well as its own individual polices covering additional risks. AWB reviews its insurance needs annually. The Corporate Risk Unit in association with AWB s insurance brokers manage this process. It involves a full analysis of the bulk handling company s risks for the joint policies and a thorough review of AWB s risk profile. The renewal is detailed and is usually completed over the July to September period, as annual cover generally expires on 30 September. Any changes to the nature or quantum of cover are discussed and agreed with AWB s broker before placement. AWB has a program of joint insurance policies with the bulk handling companies covering: stock, storage and transit; and general liability, product liability and professional indemnity insurance. AWB policies covering other insurance needs are as follows: private grain storage; industrial special risks; comprehensive crime; professional indemnity insurance (RiskAssist); directors and officers; expatriate health; marine imports/exports; charterer liability; corporate travel and personal accident; and motor vehicle. The cover in place is regarded as commercially prudent and appropriate for the nature of the risks inherent in the business. Policies are managed on an entity wide basis, including AWB and National Pool exposures. AWB uses insurers and reinsurers around the world in an effort to spread risks and seek the best cover available. Occupational health and safety The Board has a strong commitment to providing and maintaining a healthy and safe working environment for all employees and recognise AWB s obligations under applicable health and safety legislation. To achieve this objective, the focus is on consultative and cooperative practices in the workplace. Everyone has a responsibility to ensure that a safe working environment is achieved and maintained, and that real or potential occupational hazards are eliminated. Seeds technology services Where AWB s technical intellectual property is jointly owned with other parties, the ownership status is defined under the relevant agreements. Various methods are used to protect intellectual property including use of intellectual property registers, patent protection, contracts and confidentiality agreements. Currently, no genetically modified wheats are grown commercially in Australia and they are unlikely to be available in the near future. AWB is continuing to monitor customer requirements and attitudes. Funding Funding and liquidity management are the responsibility of AWB Treasury. Funding is required for grower lending, working capital and longer term asset provision through utilisation of a mixture of capital and debt. An important determinant of AWB s cost of funding is its credit rating. AWB was recently reviewed by both Standard & Poor s and Moody s. Standard & Poor s and Moody s confirmed their previous ratings of A-1+ and P-1 respectively. Management of the grower loan portfolio is performed within Board interest rate risk management policy. Debt is raised with maturity levels that align with loan assets over their maturity profile, which is generally less than one year. Residual margin risk management is then performed actively throughout the year depending on changes in the asset portfolio and the prevailing interest rate environment. Working capital management is also performed within risk committee guidelines and oversight, utilising swaps, futures and options markets to ensure that budgeted interest rate cost variances by business sector are minimised as much as possible. 92 Section 8: Risk factors and approach to risk management

5 Establishment of longer term assets on AWB s balance sheet is at present individually analysed for return and maturity characteristics. Funding provision and interest rate risk is then managed to a profile determined by executive management and the Chief Financial Officer. Currently, any offshore debt raised for domestic use is also fully hedged against foreign exchange risk. Credit risk AWB has a Trade Finance unit dedicated to trade related risk matters including counterparty and country credit limit monitoring and management as well as credit insurance control for both the National Pool and AWB. All exposures are monitored on a daily basis. Credit controls cover domestic and international sales activity as well as all treasury transactions. Credit limit reviews are performed annually, or earlier if considered desirable, and levels are determined based on factors such as asset and shareholder fund levels, agency ratings, etc. Inventory management AWB utilises a number of agents to collect, store and transport grain on behalf of the National Pool and also its trading operations. The primary agents involved are the bulk handling companies, who use many sites to store the grain. Because of this agency relationship, it is important that information flows between AWB and its agents are both timely and accurate in order for AWB to optimally risk manage the volume, value and freight cost of that grain. AWB has recently installed a new inventory management system to assist in performing that task. organisational-wide awareness and general adoption of a risk management culture when making business decisions and also in the development of systems, process change design, and enhanced general project management capability; ensure risks (strategic and operational) are formally and regularly assessed in the context of the corporate mission and vision; a robust infrastructure and management process to support ongoing review and monitoring of the status of risks, controls and risk treatment plans; clearer accountabilities for risk management, key performance and risk indicators; ongoing review and evaluation of appropriateness and integrity of corporate performance through effective interaction with the risk management unit and audit process; and enable greater ongoing co-ordination of effort between business divisions. OPERATIONAL RISK MANAGEMENT DEVELOPMENT AWB is currently seeking to formally establish an enterprise wide operational risk management framework. Its objective is to deliver: confidence that AWB s control environment is operating efficiently and effectively and is focused on maximising achievement of business objectives; assurance that systems and processes can be prepared for rapid change, growth and increased complexity; and credibility in demonstrating sound corporate governance practices to AWB s stakeholders. Specific outcomes will include: a formal framework and methodology in the determination of risk profiles and their linkage to key result areas and risk focused internal audit activity; Section 8: Risk factors and approach to risk management 93

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