‘Risk’ – a four letter word that has gained increased prominence since the financial crisis hit.
More appropriately the lack of risk management is being blamed for helping to deepen the financial crisis. Companies are now focusing on the various types of risk management techniques available to them and the list is extensive: Liquidity, collateral, counterparty, market, etc. As part of their risk management policy, companies need to decide how they are going to determine their portfolio’s exposure to the various types of risk. What happens if interest rates go up? What if we have another crash – what will be the impact on my company? The true cost of risk management comes in not having a properly defined risk management process. The consequence of having an ill-conceived or inadequate process means that your organisation has no visibility into how even the simplest changes will impact the bottom line. And using a method that is insufficient is detrimental. How do you decide where to begin? This article will examine sensitivity analysis methods in more detail and discuss some of issues you need to think about when incorporating Value-at-Risk (VaR) into your risk management process.
FAS and IFRS – regulatory pressures for better risk management
Risk calculations, such as sensitivity analysis and VaR, have been around for many years and are important components of a good risk management policy. But beyond just best practices, regulations are also requiring treasuries and finance departments to perform some kind of risk measurement in disclosures in the financial statements. In the Quantitative and Qualitative Disclosures about Market Risk section 7a under Financial Accounting Standards Board (FASB) and under International Financial Reporting Standards 7 (IFRS 7), paragraph 40 states that financial statements need to explicitly state the potential impact of market movements companies are principally exposed to:
“Financial Instruments Disclosures: a requirement exists to calculate the potential impact of each market risk variable or conduct a value-at-risk analysis.”