Today risk management is an integral part of conducting successful business. Irrespective of the size, financial structure and a location. If some years ago the companies did not recognise and did not wish to introduce risk management, today it is one of priority problems of each respective company. According to the recent interrogation North Carolina State University in partnership with the American Institute of Certified Public Accountants more than 60 percent of surveyed companies responded that the complexity of risks have changed "extensively" or "a great deal" in the last five years. However, 44 percent of respondents had no enterprise risk management process in place and had no plans to implement such a system, and 18 % did not see in it advantage. All it means that People were not ready to introduction so significant and difficult for perception risk management. However, on a current time the advantage of risk management has been proved, and the majority of the company has decided to introduce this system.
In accordance with the circumstances, with the advent of the world financial and economic crisis, very many companies have been compelled to change strategy of management by risks. As very many sectors of economy directly depend from each other, crash have suffered almost all one after another by dominoes principle. Crisis has brought many problems for businessman's, begun with the developed countries and has captured developing countries.
In this work the reasons of occurrence of financial crisis which has caused global financial and economic crisis will be discussed from the economic point of view, and will introduce fundamental reasons. This divided into several stages starting from more important to less in consequence.
The reasons and factors of occurrence of crisis are based on authoritative editions and financially-analytical institutes as Financial Times, Standard and Poor's, FERMA (Federation of European Risk Management Association), ERM COSO (Enterprise Risk Management - Integrated Framework Committee of Sponsoring Organizations of the Treadway Commission), Forbes and Wall St. Journal, Larson&Holz IT Ltd. And also will be accompanied by the statement of heads of the largest companies about crisis in a chronological order.
Chaper 2 will introduce risk magament strategy of the company, which had to change and re-evaluate their risk strategy according to the new environment caused by global crisis. This will be a case study of implementing crisis-risk management and support the points mentioned in chapter 1.
Chapter 1
Global financial-economic crisis
Definition
First of all it would be desirable to designate that there are 2 types of crises: cyclic and system. The cyclic crises are usual phenomena in economy in forms of: traditional cyclic recessions, price crises connected to external factors, such as, a rise of oil price or separate kinds of foodstuffs. Cyclic crises are frequently accompanied by bankruptcy of large parts of the market, the general decline of separate industries, or weakness of national currencies. Cyclic crises can be painful enough, but, as a rule, economic crises of this kind do not destroy economic system of the country.
System crises destroy one or several economic institutes of the country or group of the countries in which they occur concern. Basically, such crises are connected with wars and revolutions.
Hence, in spite of the fact that there was enough difficult situation for economy of all world - it is necessary to consider crisis of "today" cyclic.
Secondly, there are 3 characteristics of crisis, which are financial, economic and financial-economic. What exactly do they differ from each other?!
Financial crisis is an initial phase of crisis at which the financial systems such as banks and insurance companies suffered. However, industry and service are not suffered. The economic crisis has resulted from world crisis in those countries which strongly depends on import. The bank system practically is not influenced by economic crisis. The heaviest form of crisis is financial-economic crisis (FEC) which influences all branches of economy.
Analyses
Now it is common to considered crisis with a collapse of credit system of the USA that has involved financial and economic crisis captured all countries of the world. Actually indeed, though it was not wanted by anybody, not Americans and not others. If to investigatie this phenomenon from its fundamental, from the economic point of view clearly that crisis arose in the USA many decades. It was promoted by dollar overproduction, uncontrolled delivery of hypothecary credits, and gamble of the prices in the market. However about all one after another.
Starting directly the FEC analysis, it would be desirable to divide it into 3 stages. The first, August 10th - September 15th, 2008: the period from the beginning of the FEC and the first joint intervention of the central banks of the leading countries of the world, to bankruptcy of Lehman Brothers. The second should consider an interval of time from September 15th till April 1-2nd, 2009: time of judgement and reorientation of the American financial elite. The third stage started after April 1-2nd, 2009. It is possible name the given stage conditionally time of self-determination of leading global players.
What reasons caused the FEC, is it possible to accuse someone? Speaking to words of the president of the Russian Federation Dmitry Anatolyevich Medvedev - "time to search guilty in this illnesses has already passed, and now the main thing not to be late to find a vaccine".
Let's pass to more concrete level of a substantiation of the fundamental reasons. It has begun with crisis of a financial system and only after a year has outgrown in world financial and economic crisis. It became obvious that illness of modern global economy is getting to chronic disease of its financial system. Therefore we will be limited to detailed consideration of only two derivative factors-reasons of this disease.
Firstly, the dollar became the founder of a financial trouble, its overproduction is more exact. Since 1971 when the binding of dollar to a gold content ensured by gold reserves of the USA has been cancelled, dollars began to be printed in unlimited quantities. Buying power of dollar was ensured not only gross national product of the USA, but also gross national product of all countries of the world. Uncontrollable issue of dollar which proceeds to this day became a reference point in this global economic accident.
Stocks on world stock exchange markets in the approach to a financial crisis ten times exceeded cost of the real corporate capital in an economic occupational sector, and capitalisation of stocks of some leading corporations of electronic industry - in hundreds times.
Derivatives in comparison with currency liquidity in hundreds of time and with the increasing acceleration turn to the fictitious virtual financial assets. most powerfully suppressing regulatory function of the price mechanism of a cost constituting substance of the capital and aggravating the basic contradiction of this substance. Suppress in the sense that create the artificial demand repeatedly exceeding real size of a cost exchange in the markets. All financial assets which have exceeded by 2007 In 3,5 times of world gross national product, were a main source of inflating of financial bubbles in the hypothecary and world stock exchange markets. Therefore such "watering" world financial assets represents original cancer disease of a blood financial system, a cancer of financial blood of economic is more exact. The leading role in its distribution on the processes occurring in global economy, is played by all speculative tradings which are less regulative in capital and derivatives markets. They have led to a rise in price for gas and petroleum for the last decades in 10 - 15 times. Only for summer of 2008 in the peak of a world financial crisis, petroleum price were lifted twice, in spite of a decrease on demand.
The ancient price mechanism has been almost completely suppressed by speculative pricing in the largest megastructures of financial and real sectors of economic where it has ceased to execute roles of a reference point, a spontaneous regulator and the terminator of the tendency of the maximum component to boundless self-increase of cost. And this self-increase, having overcome internal price terminators (limiters), and external regulators, became mainly speculative, which has led to overproduction in real sector of economy and to overaccumulation of capital initially in financial structure, and then in all structures of industry.
Secondly, the objectively-subjective tendency which interaction is constant replicates two cross-currents of original cost plasma of the capital - commodity with a special value form and monetary-financial with a general value form. Let's concentrate attention to a monetary-financial flow of this plasma.
In a monetary-financial flow plasma of the world capital, constantly reproduced three interacting with one another and with a commodity stream - monetary-currency, shares and derivative contractual financial assets.
How processes occurring in each of these streams influence transformation of the potential fundamental reason of economic crises into the real?!
Monetary-financial flow
The large part of the first monetary-currency stream proceeds through bank structures. Paul Volker, a former Federal Reserve chairman, describes today's banking sector as "a demonstrably fragile financial system that has produced unimaginable wealth for some, while repeatedly risking a cascading breakdown of the system as a whole." Working as animators of transformation of deposit money into credit, stimulating debt household, industrial and investment consumption, they are "watering" their real cost basis. This in turn provides three attractors. The first - the accelerated growth of debt household especially in sector of housing trade turnover that has transformed a fast-growing part of purchased housing accommodation into the capital, because of significant annual growth of the prices for it and the low credit interest. These prices in an essential measure have acquired reflective character, all less reflecting its real value. It suppressed the price mechanism of a cost constituting substance of the capital and strengthened the tendency to the accelerated speculative self-increase of cost of the maximum constituting substance. The second attractor, strengthened action of the first, - low percent of the bank credit close to zero on purchase of housing accommodation and risky concessionary terms of crediting almost without security. It also has accelerated a rise in prices for housing accommodation and promoted high profitableness of construction. As a result the third idle time attractor began operate powerfully - the increased inflow of
(United States Census Bureau)
capital to this largest structure of economy, capital turnover of which with allowance for capitalisations of shares of a mortgage market has closely come nearer to annual gross national product of the country. Synergetic action of these three attractors has accelerated housing accommodation overproduction. Even those Americans who were unable to pay interest regularly under credits have entered into a category of happy proprietors of hypothecary housing accommodation. And as consequence, the housing accommodation in a mass order has passed into the ownership of banks, and enough people which would like to purchase it- were not. The collapse of a mortgage market of the USA has worked as a detonator of a collapse not only hypothecary, but also share markets all over the world. And after crash of several largest banks of this country the world financial crisis has outgrown into financial-economic.
Shares (stocks)
The total price of shares succesful corporations can exceed real value of their assets in tens and even hundreds times. As the price of shares of any corporation brings much bigger income, than dividends so far as main interest of shareholders and a corporate management moves from increase of their profitableness to maximisation of capitalisation of their shares at exchanges. The accelerated growth of capitalisation of shares generates fast growth not only a fictitious capital of prospering corporations, but also real monetary-financial assets, flowing from the first stream that creates illusion of durability of prosperity at their management and stimulates not so much innovative processes, how many the increase in production leading in the end to overproduction.
Derivative contractual financial assets
This market became the most large-scale of the financial resources of the world in terms of volume included in these operations, as a speed of circulation and profitableness of this financial assets impossibly high. In 2002, Warren Buffett asserted that derivatives are "financial weapons of mass destruction, carrying dangers that, while now latent, are potentially lethal." Unfortunately, his point of view was absolutely correct. Since 2002, the use of derivatives has exploded from $100 trillion to $516 trillion in 2007. That's roughly ten times the world's GDP-clearly far in excess of anything real. It would appear that such exponential growth in contracts is more for speculation than for hedging. (Bob Tapscott 2008) The overwhelming majority of operations on it is less connected with movement of cash commodities and on the contrary more with price fluctuations of assets of a share market, banks and other financial centres, and mainly is not real purchase and sale of these assets. Therefore the majority of these contracts has virtual character and represents game on price development of these assets, redistributing between its participants not only fictitious, but also real world financial assets of various grades of their liquidity. This game is extremely risky only for small and average participants. However it is predictable, even is regulated by the largest international financial speculators who have made hundred billions profit before a world financial crisis at the expense of a fast speculative rise in prices for power resources, housing accommodation, at the expense of the accelerated capitalisation of shares on share markets and at the expense of the largest gamble in the derivative market. Even more they will earn at the expense of reduction of prices on all kinds of the markets and mass buying up of the financial assets which have taken plunge in the price. Their interest in this crisis is obvious.
The effect of the current economy on employment
Bureau of labour statistics (BLS), USA
Conclusion
Long synchronisation of mentioned mechanisms of a speculative rise in prices in global economy and in a financial field have accelerated cultivation of a world financial bubble to critical level which has broken in hypothecary sector of a world share market. Its break has found out critical parametres of global economy which have transformed the latent development of spontaneous coordination of interaction of structures of production, the finance and consumption in opened decoordination, its relative orderliness into prevalence more than annual chaos in a financial field which has outgrown in world financial and economic crisis.
Risks
"Is the global economic crisis creating cracks in your supply chain? The worldwide credit crunch, lowing economies and changing consumer preferences triggered in 2008 will continue to reverberate in 2009. Benchmark research by Marsh Inc. finds that leading companies are changing their supply-chain risk practices for 2009 to better protect themselves and their customers", said Beth Enslow, Senior vice president of Marsh Inc. on her interview for The Journal of Commerce in January 2009. Her words provide that companies started to change their risk strategy at the early 2009, in order to endure crisis.
In the current economic situation banks require high credit ratings
During an economic crisis danger can arise both from expected and from unexpected sides. Therefore to endure this, organisations should react actively to danger, taking proper measures for maintenance of estimation, definition of priorities and management of risks. The risk is constantly changed under the influence of external and internal factors. It does not depend on whether there are changes in business processes of the company, or it is direct in branch. The company with strong strategy risk - management will periodically revise the programs and cards of risks, allowing a management to react to these changes as required. Correctly functioning control system of risks allows the companies to consider and evaluate various possibilities, and also to create an additional value, circumspectly accepting risks.
In addition, companies can benefited from having strong RM strategy, as in the current economic situation, lending has nearly come to a standstill. Potential lenders must now demonstrate their creditworthiness more than ever before in order to gain financing. Important role is played by risk management strategy on the credit ratings of company. Company's credit rating become vital to its borrowing power. In 2005, Standard & Poor's (S&P) began analyzing the financial service industry's risk management practices, developing criteria for assessing the RM procedures of financial institutions and insurance companies. This led to the integration of RM analysis into the rating process of various companies.
Following the successful addition of RM analyses to the ratings, S&P introduced benefits of RM analysis for non-financial organizations. Therefore, according to the new S&P approach, those organizations who failed implementation of RM in a formal, strategic way are in danger of suffering ratings reduction. Oppositely, companies fully adopted RM can improve their credit ratings, as well as gain benefit from the other aspects of having a strong RM strategy. In other words, RM implementation is vital for organisations required financing, especially these days when banks fully concentrated on creditworthiness of the lenders.
Risk during financial-economic crisis
Determining the quantity of all risks can be faced by an enterprise in the future is not easy process. The organisations possess a small amount of the relevant information concerning an origin of some risks (or it is absent). Unfortunately, it can serve as "stumbling-block" in process of risk management which is based on identification of all significant risks and their inclusion into risk management model. From the beginning of the crisis, organisations face set of risks - some of them new and others standard type, all of them could be underestimated or are not taken into consideration in the past, when the economic situation was stable. The Economist Intelligence Unit report is best described this on their report "Best Practice in Risk Management, A function comes of age" (2007) stating that their Risk Barometer had tracked a change in corporate attitudes - respondents considered credit risk and foreignâ€exchange risk to be so low on their list of priorities due to the continuing innovation that had taken place in financial risk management. (The Business Continuity Institute 2009)
During the crisis companies should introduce more detailed and universal approach to revealing risks which can potentially affect achievement of business purposes.
Example of underestimated risks
Risk card of "Kirov factory" ltd. (Russia) who faced bankruptcy during the crisis. Number four given for "credit crunch" and "crisis". Card shows very low probability and high impact of these risks. Therefore company could not survive and become bankrupt.
From the information, given in the card, it can be said that effective use of RM and choose actions for reducing each risk even low probability can avoid any problems, and survive economic downturns.
On vertical - probability, on diagonal - impact (million)
(Source: http://www.fd.ru)
Case study
Introduction
The aim of this chapter to introduce implementation of corporate risk management strategy in business.
Case study will consider corporate risk policy of one of the largest companies in the world.
The Coca-Cola Company is the largest manufacturer, distributor and marketer of non-alcoholic drinks in the world. The company established in 1886 in USA stared to sold their products within the coutry. Now they sold in more than 200 countries all over the world.
Their business is non-alcoholic beverages-mostly carbonated soft drinks, but also a variety of
noncarbonated beverages. This company manufacture concentrates and syrups, finished beverages which then be sold to bottling and canning retailers. In addition, company have ownership interests in numerous bottling and canning operations.
Approximately 50 billion beverage servings of all types consumed every day all around the world.
RISK FACTORS
Annual report of the company highlights following factors, which could materially affect their business in future periods:
Obesity and other health concerns
Water scarcity and poor quality
Changes in the nonalcoholic beverages business environment
The recent global credit crisis and its effects on credit and equity market conditions
Increased competition
Fluctuations in foreign currency exchange rates
interest rates increase
bottling partners' financial condition deteriorates
Increases in income tax rates or changes in income tax laws
Increased or new indirect taxes in the United States or in one or more of our other major markets
Increase in the cost, disruption of supply or shortage of energy
Increase in the cost, disruption of supply or shortage of ingredients or packaging materials
Unfavourable economic and political conditions
Changes in accounting standards
Climate change
Global or regional catastrophic events
Ect.
Almost all Mentioned risks identified by corporate risk management of the company are caused by economic crisis. Corporate risk management tools used to avoid or at least reduce them.
Action
In order to avoid fluctuations in interest rates and foreign currency exchange rates, commodity prices and other market risks company uses derivative financial instruments. However this action is not taken for trading purposes. Being part of corporate risk policy all derivative positions are used to reduce risk by hedging an underlying economic exposure. Generally hedging anticipated exposures up to 36 months.
Foreign Exchange
Company manage most of their foreign currency exposures on a consolidated basis, this gives an opportunity to take advantage of any natural offsets. Company generated 73 percent of operating revenues from operations outside the United States only in 2009, therefore, forieign currency plays important role, as weakness in one currency might be offset by strengths of other currencies. Derivative financial instruments are using to reduce net exposure to currency fluctuations. Company decided to enter into forward exchange contracts and purchase currency options, principally euro, Japanese yen and dollars to hedge certain portions of forecasted cash flows denominated in foreign currencies.
Interest Rates
Risk managers monitor fixed-rate and variable-rate debt, as well as short-term debt versus long-term debt. If required company enter into interest rate swap agreements to manage mix of fixed-rate and variable-rate debts.
HEDGING TRANSACTIONS AND DERIVATIVE FINANCIAL INSTRUMENTS
Corporate risk management of the company, uses derivatives as a risk management tool. The primary market risks managed by the Company through the use of derivative instruments are foreign currency exchange rate risk, commodity price risk and interest rate risk.
Management during the crisis starts with the preparation of a management plan in order to guide both
the management and the employees on what should be done to get the crisis under control with minimum loss. Decisions at this stage are undertaken under pressure, uncertainty and little time. Thus, use of
teamwork and decision-making techniques like; brain storming, Delphi method, decision trees are essential for objective decision-making. Besides managing the crisis plan, the management
should focus on increasing the productivity and the motivation of employees. At this stage, any action like
firing employees should be avoided, as these would affect employee morale.
