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The Dimensions of Risk - January 1999

By Michael Vincent

28 December, 2006

Welcome to the New Year, by all accounts it should be a reasonable one for Australia and Australian industry.  If so it is a chance for us as a country to get things right in the good times so we may suffer less in the bad which will surely come.  Risk management is becoming increasingly important but todate is still not recognised as a worthwhile discipline for the majority of Australian companies.

 

This month we again visit the mining industry, in a time characterised by soft commodity prices, changing political patterns and differing perceptions of opportunity; the Asian crisis hangs over the future if not the present.  In this environment our mining companies are required to identify, address and manage a wide range of risks to enable a reasonable level of return to shareholders.

 

Strangely though the work addressed the mining industry, the risks addressed tend to cover industry as a whole. Accordingly we can all learn from the project undertaken by Neil Watson of Western Australia.  His study sought to identify the methods by which Australian mining companies managed their risk exposures; he contacted 184 publicly listed mining companies with a questionnaire and received a reply from over 30%.  A remarkable achievement in its own right!

 

The project looked at various approaches to the following areas of risk:

 

1. Fortuitous loss: Is defined as the potential for physical damage to the assets of the company. Despite the variety of organisations involved in the survey it was found that the majority of companies selected a centralised model that was efficient in both cost and administrative structure.

2. Liability risk: Represents the exposure of a company to third parties arising out of its operations. It encompasses the potential for damage to third party property, injury or death to a third party and contractual liabilities to third parties adopted by contractual agreement. The survey evidenced a centralised model of control by most respondents, however it was interesting to note that there was a slight variation between larger more internationalised firms and smaller more concentrated ones.

3. Personnel risk: This risk reflects the exposure to a company by one of its main resources, its personnel. Injury or illness to personnel can severely impact upon the ability of a firm to maintain production and meet operating budgets. When a firm is operating internationally with expatriate staff, the effect of injury or illness can be magnified, particularly if evacuation costs are incurred. Additionally, replacement staff during absences, adds to the burden. The various laws governing workers in Australia can extend to expatriate staff overseas, indeed under the good corporate citizen model it can extend to local country staff as well. The survey indicated that this was a very centralised function and highly structured in terms of expectations and outcomes. It also demonstrated the larger the company the more centralised the control

4. Economic risk: The risk to an organisation of significant fluctuations in profitability and/or return to shareholders as a result of variations in operating results. The impact of this exposure can be seen by comparing the impact on a firm of significant property damage versus exchange rate fluctuations. A company can usually survive property damage without significant long-term change but failure to adequately cover currency exposure will lead to failure in a short time. Again in the main the respondents voted for a centralised model or interestingly failed to answer this question

5. Political risk: This to an international company is an area of diversity, the various exposures can be:

Confiscation of equity and/or property

Currency inconvertibility

Lack of ability to service debt

Loss of ability to export product

Loss of earning due to terrorism, sabotage or internal violence

 

The survey evidenced a suprising outcome in that less than half the firms', which responded, had a centralised model in operation.  The remainder had varying models from loose control to total local autonomy.

 

6. Credit risk: Credit risk varies with the type of activity. For a financier it is the risk of non-payment of loans thus reducing available cashflow for reinvestment. For a non-financial corporation it is the risk of cash flow from operations drying up due to non-observance of contractual arrangements by other parties. This is significant if the cashflow generated by operations is used to repay outstanding loans. The survey clearly show a strong tendency for centralised control, in fact 63% of replies supported a centralised risk model.

7. Risk engineering: Defined as "A systematic process for the identification and evaluation of pure loss exposures faced by an organisation or individual and for the selection and administration of the most appropriate techniques for treating such exposures." Rejda G.E. Principles of Risk Management and Insurance, Harper and Collins. Control of the loss exposure is central to the practice of risk management. The dilemma faced by firms with remote operations is how to develop and maintain an effective and consistent policy throughout all operations. If decentralised then there will be little synergy between sites; if centralised it may not receive support from the various entities involved. The survey indicated that the larger the organisation the more centralised the function of risk engineering.

Australian mining companies have significant overseas interests; the impact of these operations ensures they must manage risk effectively and efficiently in order to remain an industry with a sustainable future.

 

 Risk management as evidenced in the survey occupies a position of importance to Australian mining companies.  It also indicated that the majority of respondent risk managers hold at least an undergraduate degree and occupy executive management positions within their company.

About the Authors

Department of Accounting and Finance

Faculty of Business and Economics

Monash University

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