In January 2008, Group CEO of the Future Group Kishore Biyani gave his staff a war cry: Garv se kaho hum kanjoos hain. He had sensed that real estate prices were rising, and costs of acquiring people and, in general, doing business were going through the roof. “The markets had been doing well before that and we’d been taking so much risk, but that clearly couldn’t go on,” he recalls.
Realisation about risk-reduction, however, really set in when the company began to feel the pain from deteriorating market conditions during the slowdown. Biyani converted his management style to “get more out of the same” and senstivised the entire organisation to measuring the overall risk in every possible scenario. “We’ve now turned too defensive and I am trying to get us out of this mode to exercise controlled aggression,” he says. The company is attempting to strike a better balance between risk and caution with a leadership conclave in early November that will assess future risks, amongst other things.
PERILS OF IGNORING RISK
|Firms are becoming more conscious about the need to minimise risk in today’s business landscape.|
|However, most have not been rigorous about embedding a culture of risk mitigation in their company’s DNA.|
|Firms that ignore catastrophes, which have a low probability of occurring, could face devastating consequences.|
|Firms need to figure out where to place bets, where to hedge them, and where to avoid betting altogether.|
Fact is, Biyani aside, few Indian companies have been fully cognisant of the sizable risks that increasingly confront their businesses in an era where wild swings in commodity prices, fluctuations in currencies or an improper assessment of political or business landscapes have damaged companies. For instance, getting a handle on complex financial derivatives would have saved Hexaware and Wockhardt from the colossal hits they took last financial year. The slowdown in the last year has only heightened the vulnerability of firms who haven’t safeguarded themselves.
Some companies, however, seem to be waking up to the urgent need to manage risk. A recent Ernst & Young survey shows the size, magnitude and reach of risk-management functions are on the rise in bigger companies. Today, the more enlightened of independent directors have begun questioning vulnerabilities and Boards in general are calling for risk reduction. “By and large, risk management in India commenced with identification of risks for the purposes of complying with the regulation of Clause 49 of the Listing Agreement,” says Neville Dumasia, Head of Governance, Risk & Compliance Services at KPMG. “But when Lehman happened, Indian companies started asking what went so wrong and they figured that there had been a lack of following robust riskmanagement practices and perhaps overruling of the basic tenets,” he adds.
Still, fact is, the transformation of this gradual awareness into a risk culture that is embedded into the DNA of organisations is far from reality. E&Y’s survey shows that a significant proportion of top companies still do not have a clearly-defined charter for internal audits. The effort spent on internal controls over financial reporting (ICFR) is still not comparable to global benchmarks. And the momentum gained through Clause 49 compliance (which mandated identification of certain types of risk) efforts is now reducing.
Problem is, Clause 49-driven risk management is limited to processes. It does not pay adequate attention to other kinds of risk such as sovereign, currency, commodity, and strategic risk. Companies investing in new projects that fail to sufficiently cushion themselves from the risk emanating from, say, operating in a country that has fickle power supply, chronic labour problems or a high rate of kidnapping of businessmen, can be in for a nasty surprise. Sometimes, the probability of catastrophic risks occurring is so low that it simply drops below the radar screen. “Organisations failed to think through the scenarios and underestimated the interconnectivity between the risks. If the risk of a catastrophic event happening was only 1 per cent, it was mentally dismissed,” says Ram Sarvepalli, Risk Head for E&Y.
There are, however, a few firms like Biyani’s, which have managed to thrive in an era of uncertainty. When the Sensex was struggling around half of what it is now, very few companies seized the opportunity to reduce their foreign debt raised in the form of foreign currency convertible bonds (FCCBs). One of the few to benefit from the weakness in stock markets was Hotel Leela Venture. In the weeks before the year ended in March, the hospitality group repaid a quarter of its euro debt and a third of its dollar debt with FCCB buybacks at a huge discount. In other words, the group cleared a good part of its debt by paying back less than what it had raised. “The FCCB buyback was one of our key risk-mitigating initiatives,” says V.L. Ganesh, Director (Finance) and Chief Financial Officer (CFO), Hotel Leela Venture. “We took advantage of the depressed prices of FCCBs, bought back a major percentage of exposure and derived a major profit in the process,” he adds.
For Apollo Tyres, the management of fluctuations in prices and supply of raw materials—mainly commodities such as rubber and crude—have always been a big challenge and its ability to do this well saw it emerge relatively unscathed from the turbulence of the last few years. Apollo had set up forecast models three years ago for managing this key vulnerability which feeds into a risk map that aggregates the exposure of each functional department. Last year, before the quarter ended in March, global commodity prices skyrocketed, and the raw material risk-rating hit the critical level of 5 on a meter of 1 to 5. Apollo scrambled to soften the impact using a twopronged strategy: some of the expected price rise was passed on to consumers and inventories were built to prepare against higher future costs. The risk management model protected the company and aided its sharp recovery starting January 2009. Today, the company seems to be more aware of risk than ever. “If our internal audit officers or Board members earlier asked us 10 questions related to risk, they are now asking a few more than that. They want to know what could go wrong and how robust are our practices,” says Sunam Sarkar, CFO, Apollo Tyres.
The lesson to learn from these companies is not to avoid risk altogether— after all, without risk, there would be no rewards. The point is for companies to manage risk well— that is, to choose where to place bets, where to hedge bets, and where to avoid betting altogether.