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List of Figures
1. Holistic approach to Corporate Risk Management and Outcome of Risks ... 3
2. The Risk Management Process ... 8
3. Hedging Currency Risks in China ... 23
iv
List of Tables
1. Common Financial Risks of Corporations ... 4
2. Common Non-Financial Risks of Corporations ... 6
v
List of Abbreviations
B2B
business-to-business
BRICS
Brazil, Russia, India, China and South Africa
COSO
Committee of Sponsoring Organizations of the Treadway Commission
CIVETS
Colombia, Indonesia, Vietnam, Egypt, Turkey and South Africa
DM Developed
Market
e.
g.
exempli
gratia
EM Emerging
Market
ERM
Enterprise
Risk
Management
GDP
Gross
Domestic
Product
GNI
Gross
National
Income
KRI
Key
Risk
Indicators
IMF
International
Monetary
Fund
LSE
London
Stock
Exchange
MINT
Mexico, Indonesia, Nigeria and Turkey
MNE
Multinational
Enterprise
p.
page
SWOT
Strength, Weaknesses, Opportunities and Threats
UK United
Kingdom
VaR
Value
at
Risk
WEO
World
Economic
Outlook
vi
1. Introduction
Emerging Markets: An acronym for growth, opportunities and high rewards. EMs
symbolize bustling, dynamic and thriving economies. These type of countries are char-
acterized by high population growth rates and tremendously skilled talents, benefitting
from technological expansions and an increase in living standards. They are seen as
nations with a bright future and high potential to become an advanced economy in the
long
term.
Corporations see enormous chances to lower their costs and increase their rev-
enue in EMs. Since the majority of the world's population lives in EMs, they offer tre-
mendous potential. Operating successfully in EMs has become a must for multinational
enterprises (MNEs). However, in many cases manager highly understate the risks that
corporations can face in EMs (Broadman, 2012, p. 44) [7]. An undeveloped infrastruc-
ture, violence and crime, corruption, environmental disasters and political instability are
only a few characteristics that become challenging for organisations in emerging coun-
tries (Hochberg, Klick, & Reilly, 2015) [40]. The Harvard Business Review conducted
a survey which showed that the majority of the consulted corporations suffered losses,
thus managing risks insufficiently in EMs (Hochberg, Klick, & Reilly, 2015) [40]. On
that basis there is the assumption that managing risks is far more complicated in EMs
than
in
DMs.
This paper deals with an overview of managing risks in EMs. It points out the
characteristics of risk management in EMs and compares them to DMs. The first chap-
ter deals with the basic definition of corporate risk management and introduces basic
types of enterprise risks. Additionally, it covers (1) the risk management process, (2)
the measurement of risk and (3) enumerates the most common techniques to mitigate
corporate risks. The second chapter gives a brief introduction of EMs and their envi-
ronment. The chapter proceeds with an overview of exposures in EMs and the examina-
tion of (1) the risk management process, (2) the measurements of risks and (3) the miti-
gation of risk in Emerging Markets compared to DMs.
The thesis focuses on corporate risk management in EMs and does not consider
risk management of capital investments. In that regard enterprises that are headquar-
tered in EMs and enterprises that are based in DMs were taken into account.
1
2. Conventional Corporate Risk Management
This chapter outlines the basic definition of corporate risk management and introduces
common types of corporate risks. It continues with an overview of the risk management
process, the measurement of risk and tools for risk mitigation in developed countries.
2.1. General Definition of Corporate Risk Management
"Risk comes from not knowing what you're doing."
- Warren Buffett
Corporate risk management, also often referred to as Enterprise risk management
(ERM), defines the "overall risk management approach to business risk" (D'Arcy, 2001,
p. 1) [17]. According to Merna & Al Thani (2008, p. 2) [56], the main purposes of cor-
porate risk management are (1) the identification of risk, (2) "analysis of risks specific
to the organisation" and (3) to address the exposures in a compelling manner.
Meulbroek (2004, p. 57) [52] identifies the main aim of corporate risk man-
agement as "maximising shareholder value". Hampton (2015, p. 20) [31] specifies the
aim and determines the following business needs as motives for implementing an ERM:
(1) survival, (2) stability, (3) fiduciary responsibility, (4) ethics and (5) observing regu-
lations. Thus, every company needs to survive; it is essential to identify dangers that
can damage the business. Furthermore, it is easier to achieve a stable business by know-
ing its risks. Additionally, an ERM helps a company's stakeholder to know their fiduci-
ary responsibility and creates creditability (Hampton, 2015, p. 21) [31]. Moreover, regu-
lations and guidelines like, e.g. from the Financial Reporting Council require companies
to control their risks and to improve their risk management standards constantly
(Financial Reporting Council, 2014, p. 1) [22].
1
In literature, corporate risk management is determined to be a new model
for managing risks of an organisation (Olson & Wu, 2008, p. 3) [65]. Established in the
mid-1990s, corporate risk management emerged through failures of high-profile com-
panies that were managing their risk within each individual department and business
unit (Dickinson, 2001, p. 360) [18]. Such a "silo approach to risk management" causes
that enterprise-wide risk might not be identified or managed correctly (Sweeting, 2011,
1
All premium-listed companies at the LSE are expected to meet the UK Government Code, which is
overseen by The Financial Reporting Council and includes the application of the Enterprise Risk Man-
agement Process (Financial Reporting Council, 2014, S. 1) [22].
2
p. 3) [71]. Figure 1 illustrates the possible risk outcomes on each level of an organisa-
tion and helps to understand that risk management is seen as a holistic system within an
enterprise.
On a corporate level, the management deals with long-term risks including a low level
of detail, whereas the risk management on a strategic business level and a project level
involves short-term risks with a high level on detail. Consequently, these various ap-
proaches to risk management are summarized as ERM (Merna & Al-Thani, 2008, p. 3)
[56]. For this reason, according to Steinberg et al. (2004, p. 2) [78] risk management is
an integral part of the management's duties, which has an effect on the overall entity's
performance. That goes in line with Yener (2010, p. 506) [92], who adds, that "ERM
offers companies strategically more effective risk management" and decreases costs.
2.2 The Concept of Enterprise Risk
The word `risk' was included into the English language "in the mid seventeenth centu-
ry" and finds its origin in the Arabic and Latin language (Merna & Al-Thani, 2008, p. 9)
[56]. In today's literature, "`risk' has a number of meanings, and it is important to avoid
ambiguity when risk is referred to" (Sweeting, 2011, p. 1) [71]. Wharton (1992, p. 41)
[89] points out that over the years the key proposition changed from an uncertain reac-
tion to a situation or determination that describes the possibility for an unwanted result,
caused through an undesirable event. Steinberg et al. (2004, p. 2) [78] agrees to Whar-
ton's definition and states that "events with a negative impact represent risks, which can
prevent value creation or erode existing value". In contrast, Merna & Al-Thani (2008, p.
4) [56] say that it is important that risks should not always be considered threats. De-
Corporate
Level
Strategic Business Level
Project Level
Enterprise Risk Management
sk M
level
Figure 1: Holistic Approach to Corporate Risk Management approach and outcome of risks
Note: Own description on basis of Merna (2003, p. 90) [54]
3
pending on the situation and a well-functioning risk management, risk can even be con-
sidered an opportunity (Merna Al-Thani, 2008, p. 4) [56]. Agreeing with that Culp
(2002, p. 15) [8] states: "in general, the conceptual perspective on risk varies with the
perspective". However, in literature the most common definition of risk is an event that
leads to financial losses (Culp, 2002, p. 15) [8].
2.3 Types of Corporate Risks
According to Sweeting (2011, p. 93) [71] it is crucial to prioritize the risks of an enter-
prise, because of their high number. Furthermore, he reports that the exposures depend
on the corporation itself and its industry. It is obvious that new risks occur over time
and others disappear. Therefore no list can consider all exposures (Merna Njiru,
1998, p. 128) [53]. According to Sullivan Fragnière (2007, p. 21-22) [70] corporate
exposures are dividable into financial risks and non-financial risks.
Financial risks usually have a direct impact on the monetary performance of an
enterprise, whereas non-financial risks have a major influence on the overall business
activity in the first place (Merna Al-Thani, 2008, p. 128-130) [56]. The following
paragraphs will introduce common types of financial and non-financial risks.
2.3.1 Financial Risks
As Merna Al-Thani (2008, p. 128) [56] report in their book, financial risks affect the
financial performance of an enterprise. They consist of several types of exposure asso-
ciated with finance and actions that have a direct impact on the financial performance of
a company (Merna Al-Thani, 2008, p. 126) [56]. Mostly caused by external events,
they lead to (1) reduced cash flow, (2) reduced market value and (3) reduced account-
ing income (Fraser Simkins, 2010, p. 322) [23]. Table 1 lists and defines common
financial risks that companies face in industrially developed countries are summarized
in the following list.
Currency risk
The change of value by volatile currency exchange rates is significant
to multinational enterprises. Researchers of the International Mone-
tary Fund (IMF) define currency risks as the chance of a loss in bal-
ance sheet items or cash flows through currency rate changes
4
(Papaioannou, 2006, p. 4) [67]. Additionally, Shopiro (1996, p. 32)
[77] mentions that currency risk can be caused from (1) cross-
boarder transactions, (2) invested capital in foreign currencies or (3)
expected cash flow in a foreign currency.
Interest risk
Interest rate changes have a direct impact on the demand for bonds
offered by an enterprise. When market interest rates rise, the demand
for corporate bonds will decrease and the enterprise needs to issue
new bonds with higher-fixed rates to raise capital (Merna Njiru,
1998, p. 199) [53]. Moreover, Merna Njiru (1998, p. 199) [53]
mention that bank liabilities that bear interest and "have a longer ma-
turity" as an additional interest rate exposure. When the maturity is
divided into smaller terms the company suffers from higher interest
payments, in case interest rates rise.
Liquidity risk
Khu (2002, p. 128) [45] defines liquidity risk as a fundamental cash
flow issue and divides it into funding liquidity risk and market li-
quidity risk. Funding liquidity risk is described as being unable to pay
the expenses of the enterprise or funding the liabilities. Market liquid-
ity, on the other hand, involves selling assets at a lower price than its
true value (Merna Al-Thani, 2008, p. 128) [56].
Taxation risk
Taxation risk includes the exposure of tax rate changes. A deprecia-
tion of the tax rate lowers the net profit and leads to smaller cash
flows for an enterprise (Merna Al-Thani, 2008, p. 129) [56].
Trade
credit risk
Trade Credit Risk is an exposure that especially affects especially
trading companies in the B2B industry and banks. It is caused by a
counterparty in a trade contract, when the company does not commit
to the "obligations stated in the contract" (Rutkowski Bielecki,
2013, p. 3) [69]. In most cases the company can't balance its paya-
bles, because of insolvency. Then, the exposure affects the lender that
has unbalanced liabilities (Rutkowski Bielecki, 2013, p. 3) [69].
Table 1: Common Financial Risks of Corporations
5
Summing up, it is evident that the list could enumerate several more risk types, although
they are not the most common. For instance, Hampton (2011, p. 2) [32] reports that
each MNE faces on average 800 financial risks "across all business units".
2.3.2 Non-Financial Risks
Exposures that don't have a direct impact on the cash flow of a firm and are not mone-
tary in the first place are associated as non-financial risks (Merna Al-Thani, 2008, p.
130) [56]. Furthermore, Sullivan and Fragnière (2007, p. 22) [70] define non-financial
risk as interruptions of the business. Next, table 2 lists and defines common non-
financial risks.
Political risk
Political risk is determined by changes of the government or policies
that cause "strategic, financial and personnel loss for the firm"
(Kennedy, 1988, p. 27) [43]. By the introduction of new laws or sanc-
tions the power of interaction with clients or business partners can
decrease and lead to less efficiency for the company (Allianz SE et al.,
2016, p. 5) [1].
Cyber risk
Hida (2015, p. 51) [33] describes cyber risks as the exposure of being
hacked by external organisations. Since every enterprise depends on
information technology, cybercrime and technical failure can cause
high damage to the company through data loss and process interrup-
tion.
Market
developments
It implies sudden changes in the market which the corporation is tar-
geting. "Intensified competition, particularly from non-traditional
competitors and agile start-ups, is one of the drivers behind market
developments" (Allianz SE et al., 2016, p. 3) [1]. These changes in
market structure can decrease sales of the enterprise, cause pricing
pressure and influence the prospective market power (Mohammed
Sykes, 2012, p. 3) [59].
Regulatory
compliance
risk
Regulatory compliance risk is defined as the uncertainty "of a change
in regulations and law that might affect an industry or a business"
(Ergas et al., 2001, p. 1) [20]. Furthermore, Ergas et al. (2001, S. 1)
6
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