Hydro One Inc.
Aabo, Frase & Simkins [2005] Jurnal of Applied Corporate Finance 17:3, 62-75
Ontario electrical distributor
Formed in 1999 (privatized)
IPO 2001 (withdrawn)
Finland May 2010
ERM at Hydro One
• Late 1999 head of Internal Audit appointed
CRO
• Corporate Risk Management Group
established
– CRO, 2 full-time professionals
– Given 6 months to prove themselves
– Early 2000 prepared
• ERM Policy
• ERM Framework
Finland May 2010
ERM Policy
•
Audit & Finance Committee of the Board
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•
President
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specific accountabilities for managing risks in their subsidiary or function
each will establish specific risk tolerances for their lines of business that do not exceed the limits of corporate risk tolerances
expected to annually formally attest that the unit’s risk management process is in place, operating effectively and is consistent with
this policy.
Line and Functional Managers
–
–
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provides management oversight of the Hydro One risk portfolio and the Corporation’s risk management processes
provides direction on the evaluation of these processes
identifies priority areas of focus for risk assessment and mitigation planning
Each of the President’s Direct Reports
–
–
–
•
specific accountability for ensuring that enterprise risk management processes are established, properly documented and
maintained
Senior Management Team
–
–
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•
ultimate accountability for managing the Corporation’s risks
Chief Financial Officer
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Annually reviews the Corporation’s risk profile, the risk retention philosophy/risk tolerances of the Corporation, and the risk
management policies, processes and accountabilities
responsible for managing risks within the scope of their authority and accountability
risk acceptance or mitigation decisions made explicitly and within the risk tolerances specified by the head of the subsidiary or
function
Chief Risk Officer
–
–
provides support to the President, CFO, Senior Management Team and key managers within the corporation
includes developing risk management policies, frameworks and processes, introducing and promoting new techniques, preparing
annual corporate risk profiles, maintaining a registry of key business risks, and facilitating risk assessments across the Corporation
Finland May 2010
Risk Definitions
from Risk Policy
•
Risk:
– potential that an event, action or inaction will threaten Hydro One’s ability to
achieve its business objectives. Risk is described in terms of its likelihood of
occurrence and potential impact or magnitude. Broad categories of risk in Hydro
One include strategic, financial, and operational risks.
•
Risk Assessment:
– systematic identification and measurement of business risks on a project, line of
business or corporate basis. It also includes the review or establishment of risk
tolerances, the evaluation of existing mitigation controls and conscious
acceptance or treatment of residual risk.
•
Risk Mitigation/Treatment:
– Actions or decisions by management that will change the status of a risk.
Options include
•
•
•
•
•
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retaining the risk (either completely or partially),
increasing the risk (where mitigation is not cost-effective),
avoiding the risk (by withdrawing from or ceasing the activity),
reducing the likelihood (by increasing preventive controls),
reducing the consequences (by emergency or crisis response),
and/or transferring the risk (by outsourcing, insurance, etc.).
Finland May 2010
Risk Definitions
From Risk Policy
• Risk Profile:
– results of any risk assessment, assembled into a consolidated
view of the significant strategic, regulatory, financial and
operational risks at play in a project, line of business or across
the Corporation.
• Risk Tolerances:
– Guidelines first establish levels of acceptable and unacceptable
exposure from any risk.
– Tolerances define the range of possible impacts (from minor to
catastrophic) that risks might have on business objectives.
– Risk tolerances are established for the Corporation and reviewed
annually.
– Each project, function or line of business assessing its risks is
expected to use or develop a set of risk tolerances that does not
exceed established corporate limits.
Finland May 2010
Risk Management Process
• Establish Business Context
• Identify Risks
– What can happen?/How?
• Assess Risks & Controls
– Determine consequence
• Assess Current Controls
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Confirm existence/Determine effectiveness
Estimate strength of controls
Determine likelihood
Estimate level of risk
• Check if Risk is Tolerable
– If not, Mitigate/Treat Risks
Finland May 2010
Dimensions of Likelihood
5 – Virtually certain
0.95 probability will occur within 5 years
4 – Very likely
0.75 probability will occur within 5 years
3 – Even odds
0.50 probability will occur within 5 years
2 – Unlikely
0.25 probability will occur within 5 years
1 – Remote
0.05 probability will occur within 5 years
Finland May 2010
Risk Magnitude
1. Minor
•
2.
3.
4.
5.
few controls needed
Moderate
Major
Severe
Worst case
•
full prescriptive controls with executive
oversight
Finland May 2010
Means of Dealing with Risk
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Retain
– risk exposure accepted without mitigation, since potential return is viewed as
desirable and downside exposure is not significant;
•
Retain but change mitigation
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a partially mitigated exposure is maintained, but change in mitigation reduces
the cost of control;
Increase
– risk exposure is increased, either because the potential return is viewed as
desirable or the controls in place are not cost effective;
•
Avoid
– risk exposure to be entirely eliminated, possibly by withdrawal from a business
area, since the potential return does not offset downside exposure;
•
Reduce the likelihood
– risk exposure reduced cost-effectively through new or enhanced preventive
controls;
•
Reduce the consequences
– impact of any risk that materializes will be reduced through emergency
preparedness or crisis response;
Finland May 2010
Hydro One Risk Tolerances
3 of 16 total
Financial
Reputation
1 Minor
<$5M loss
Letter to Govt, <1000
mgmt
<10MW
2 Moderate
$5-25M
Local
3 Major
$25-75M
Provincial
4 Severe
$75-150M
National
5 Worst
>$150M
International
Finland May 2010
Reliability
1-10k
10-100MW
10-40k
100-400MW
40-100k
400-1k MW
>100k
>1MW
Pilot Study
• Spring 2000 workshop
• One subsidiary
• Pre-meeting – e-mailed participants
– Asked for list of 10 most critical risks
– Compiled, top eight selected
• Delphi
• Vote on 1-5 scale
• Discuss
– Iterate
• Deemed successful
– ERM continued
Finland May 2010
Corporate Risk Profile
Risk source
Trend
Mitigation
Growth
Very high, up
Senior mgmt
participation in govt
Regulatory
Very high, up
Org. Readiness
High, up
More board
participation; Add
regulatory staff
Contracting, labor rel.,
technology
Network subs.
High, new
Finland May 2010
Strategy & transition
plan
Corporate Risk Profile
Risk source
Trend
Mitigation
Asset condition High, even
Redundancy, emergency
response
Catastrophic
events
High, down Planning, forecasting,
insurance
Environmental
Contamination
High, even
Hazardous
operations
Medium, up Design, maintenance,
training, supervision
Insurance
Finland May 2010
Corporate Risk Profile
Risk source
Trend
Mitigation
Market ready
project
Medium,
even
Delay market entry
New electricity
marketplace
Medium,
even
Participate on market
board, negotiate
Economy/
financial markets
Medium,
down
Limit floating rate debt,
interest rate swaps,
diversified customer base
Finland May 2010
Benefits of ERM
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Lower debt cost:
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Capital expenditures focused on greatest risk mitigation per investment:
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Board of Directors was initially skeptical
now routinely expects risk analysis
Implement formalized risk management system:
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ERM workshops aided the executive team to articulate risks faced
Many other examples of stakeholder reassurance existed.
Improve corporate governance:
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dismissal of the Board of Directors and reaction to the oil spill.
Reassurance to stakeholders that the business is well managed:
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the risk-based structural approach yielded an optimal portfolio of capital investments
Catastrophe avoidance:
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Initial debt issue was oversubscribed about 50 percent, and ERM was credited by ratings
analysts as being a significant factor in high ratings received
Formalized system drives periodic assessment, documentation, and risk reporting
Identify risks where Hydro One is most competitive:
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A subsidiary involved in marketing electricity was sold due to high commodity risks
several processing and administrative functions were outsourced to transfer labor union and
cost risks
Finland May 2010