Financial Strategy & Behavioral Finance

Framework for Risk Management

Components of Global Risk facing Multi-national Organizations:

•Cultural & Behavioral•Political•Economic

•Planning & Identification•Mitigation & Execution•Measurement & Reporting

Enterprise Risk Mgmt•Determine Risk Profile

Organizational collaborationMarket toleranceMacro/Micro economics; scale & scopeEconomic scale refers to our size (total assets, equity and sales) while Economic scope refers to our diversity of operations; Foreign Direct Investment (FDI), including the number of geographic locations, and complexity of operations. While size reflects economic scale and foreign operations reflect economic scope, the level of income reflects both economic scale and scope. The level of income reflects economic scale because the size of the company influences the size of pre-tax income. The level of income reflects economic scope because the diversity of the company’s operations influences a company’s ability to offset losses with income from other business segments.

•Set goalsReview best practice

•Implement controls & execute policies•Identify, mitigate, & measure exposures

If necessary, account for transactions

•Monitor and manage exposure

Enterprise Risk Mgmt

COSO Framework

What is it? - COSO

Comprising the professional associations, the Committee of Sponsoring Organizations (COSO) is a voluntary private-sector organization. COSO is dedicated to guiding executive management and governance entities toward the establishment of more effective, efficient, and ethical business operations on a global basis. It sponsors and disseminates frameworks and guidance based on in-depth research, analysis, and best practices.

COSO FrameworkThe COSO Internal Control Integrated FrameworkThe COSO Framework defines internal control as:

A process, effected by an entity’s board of directors, management and other personnel, designed to provide reasonable assurance regarding the achievement of objectives in the following categories:

Control environmentThe control environment is based on the individual attributes and attitudes of senior management of the Company – and will reflect their integrity, ethical values, competence and authority. The control environment is a foundation for all the other components of internal control and is the nature of the platform on which the whole organization is built.

Risk assessmentThis is the awareness and response of the Company to the risks that it faces.

Control activitiesControl activities are the policies and procedures that are designed and operate in order to manage and address the risks to the achievement of Company objectives.

COSO Framework Con’tInformation and communicationInformation and communication systems are required to support the other four components in order to ensure the people in an organization understand, capture, exchange and record the information needed to manage and control risk in an organization.

MonitoringThe entire process, but particularly controls and processes, must be monitored to assess their effectiveness and to identify where modifications or remedial actions are necessary.

COSO Framework application to financial risk management:Effectiveness and efficiency of operations = Transactional & Operational risk: The effectiveness and efficiency of financial management. This would include the financial and operational objectives throughout the Company.Reliability of financial reporting = Financial accounting risk:Relates to the preparation of reliable financial information for inclusion in the financial statements and selected financial data derived from such statements, such as earnings releases, reported publically.

Type of RISK Events giving rise to RISK

Transactional Acquisitions

Disposals

Mergers

Financing transactions

Cross-border [ICTP]

Internal reorganizations

Operational New business ventures

New operating models

Operating in new locations

New operating structures

Impact of technological developments

Compliance Lack of proper management

Weak accounting records or controls

Data integrity issues

Insufficient resources

System changes

Legislative changes

Revenue investigations

Financial accounting Change in legislation

Changes in accounting systems

Changes in accounting policies & GAAP/IFRS

Portfolio A combination of any of the events listed

Management Changes in personnel

Experienced tax staff lacking

New/inexperienced resources

Reputational Revenue authority investigation

Press comments

Court hearings/legal actions

Political developments

COSO Assessment Table

COSO Response to RiskResponse to Risk

AvoidanceTaking alternative action such that the risk no longer arises, forexample by operating using a different model such as: i.e….– using arms length transfer price to avoid a transfer pricing tax risk; or– restructuring an asset disposal to be a sale of a shareholding in acompany owning those same assets; or– to operate through a legal entity with a different taxable status ina particular location

SharingTaking action to reduce the likelihood or impact of the risk by transferringor sharing the risk in some way. This generally achieved through thetechniques such as the obtaining of warranties or indemnities, obtainingprofessional opinions, or outsourcing of financial functions

ReductionTaking action to reduce the likelihood of the occurrence and/or theimpact of the risk, for example by:– carrying out appropriate financial planning; or– obtaining documentary evidence or opinions in support of theproposed financial treatment such as a valuation, or– restructuring the event to give a more favorable financial treatment e.g.by leasing rather than buying a capital asset; or– carrying out a detailed review of potentially disallowable expenditureto ensure all potentially allowable amounts have been identifiedand claimed

Manage Risk

Model:

Identify Manage Monitor Report

This process can be used for complex exposures

What is the company risk profile?

Architecture - Define and Identify Exposure

Treasury

Data collection

General Manager

Business locations

Goals, objectives, methodology Systems

[Identify, measure, monitor and report]

Collection & analysis

Business Controller

Corporate

Actions/decisions

Methodology, tools & strategy

Formulate a strategy

• Model:

Identified exposure

Controller/exposure Analysis & data

Economic informationIndustry Information

Statistical InformationMarket Information

Contingency Plan

Strategy Execution

Identified exposure

Develop a View

Goals & objectives

Tax/Treasury

Executing a Hedging Strategy

Implement internal hedge

Decision not to hedgeExecute external market hedge

Strategy

Implementation

Execution

Internal hedge opportunities

Financial institution knowledge

Hedge product knowledge

Pulling it together?!

Legal Entity Model

• What is your treasury business plan?

• What business design is needed? i.e.

– Typical buy-sell arrangement

– Limited risk distributor

– Contract manufacturer

– Commissionaire/FSO office

• What are the commercial treasury risks?

• What are your internal requirements?

Legal Entity ModelsType Buy-sell Limited Risk

Distributor

Commissionaire Agent

Legal title of goods Distributor to customer,

DT has title

LRD to customer,

LRD has flash title

Principal direct to

customer

Principal direct to

customer

Invoicing the

Customer

Distributor invoices

customer

LRD invoices

customer

Commissionaire

invoices customer

Principal invoices

customer

Advantages Centralized inventory &

ownership

Centralized functions &

risks

Relatively simple to

implement

Low PE risk

Same face to customer

Central inventory risk

& ownership

Centralized functions

& risks

Relatively simple to

implement

Low PE risk

Same face to

customer

Central inventory risk &

ownership

Same face to customer

Low PE risks

Centralized functions

and risks possible

Central inventory

risk & ownership

Centralized

functions & risks

Relatively simple to

implement

Disadvantages AR on the books of

sales company

Higher reported sales

in local entity

Bears more risk; both

operational &

commercial

AR on the books of

sales company

Higher reported sales

in local entity; e.g. stat

reporting

Bears less risk; e.g.

currency exposure

VAT & Acc’t complex to

implement due to buy-

sell for VAT and

Commissionaire agent

for accounting

PE risks in common law

countries; e.g. UK

Two faces to the

customer [sales &

Invoice]

PE risk for principal

Conversion risk

may be higher

Treasury Considerations• Capitalization

– Funding – relationship dictates wholly owned, minority interest, partnership, etc.

– Bank account establishment(s)• Purpose, control & authority

– Functional currency & reporting

– Transactional FX mitigation

• Thin Capitalization & intercompany loans– Debt to equity

• Capital Reduction– Steps

• Sale – asset/stock– Value Book versus Tax

• Wind-up/exit strategy