Enterprise Risk Management (ERM) Analysis for Credit Ratings of Non-financial Companies - ACT Response

Effective risk management is recognised as a significant element in optimising the predictability of cash flows and company valuations. It has consequently become increasingly important to organisations as part of both strategic and tactical business development. Investors should benefit from risk management processes which attempt to address the firm’s risk environment, mitigate the financial cost of business disruption and loss and reduce excess risk capital held against non-remunerated risks.

Making investors aware of whether firms have ERM in place and what resource and emphasis the management place on it is to be commended. Our concern is that in non-financial businesses the concepts and implications of ERM appropriate to financial companies will not provide comparably useful, measurable and qualitative results. Further empirical work needs to be done.

Our key concerns are as follows:

• The risk environments for financial and non-financial businesses have many components in common. However they are also materially different. Assessment of the ERM framework for a non-financial business with the objective of contributing to the assessment of the firm’s propensity to default but using an approach from the financial sector, must make all due allowance for these differences. It is unlikely to be measurable in the same way
• The ACT has reservations about whether the paper’s proposed approach to identifying and measuring risk, and scoring the effectiveness of an ERM, will be properly appropriate to a ratings review of default probability in non-financial businesses. We agree that too complex a scaling should be avoided. This is particularly an area where the agency’s judgement, simply set out, is what ratings users will be looking for.