Heitor Moura

A RISK MANAGEMENT PLAN

for an investment and trading project

January 2007

UNICONSULT SERVIÇOS TÉCNICOS LTDA. – RIO DE JANEIRO

 Risk and its management

• Risk is the possibility that an event will occur, which adversely

affects the achievement of objectives.

• Risk management is:

• an on-going process, a means to an end;
• carried out through plans, policies, surveys, controls, information and
fundamentally by people;
• applied in a strategic setting, that is, directed towards objectives;
• applied throughout the organization, at all hierarchical levels and regional units;
• aimed at identifying and managing potential adverse events and situations;
• designed to offer reasonable assurance to its management and board of the
organization's understanding of risks and of its capability of minimizing their
effect.

PROJECT jANUARY 2007 2

 Risk Management Process

RISK MANAGEMENT
PLANNING

RISK MANAGEMENT
MONITORING

RISK OCCURRENCE
RESPONSE

PROJECT jANUARY 2007 3

 Risk Management Process - Planning
RISK MANAGEMENT
PLANNING

RISK IDENTIFICATION RISK MANAGEMENT

MONITORING

RISK OCCURRENCE
RESPONSE

RISK OF DELAY IN
INVESTMENT DECISION RISK ASSESSMENT

LIKELIHOOD: IMPROBABLE MITIGATION OF

IMPACT: SMALL LIKELIHOOD
TIME-FRAME: SHORT-TERM

PROJECT SCHEDULE MITIGATION OF

EVENTUAL IMPACT

SIMULTANEOUS PROJECTS
PARTIAL-DECISION PROCESS RISK-RESPONSE PLAN

PROJECT jANUARY 2007 4

 Risk Management Process - Monitoring
RISK MANAGEMENT
PLANNING

MONITORING RISK MANAGEMENT

MONITORING

RISK OCCURRENCE
RESPONSE
FOLLOW-UP OF
CONTINUED RISK
NEGOTIATION PROCESS
ASSESSMENT

CHANGE TO LIKELIHOOD? REVIEW MITIGATION OF

CHANGE TO IMPACT? LIKELIHOOD
CANGE TO TIME-FRAME?

REVISION OF SCHEDULE REVIEW MITIGATION OF

EVENTUAL IMPACT

ACCELERATE NEGOTIATIONS
OPEN NEW NEGOTIATIONS REVIEW RISK-RESPONSE
ETC. PLAN

PROJECT jANUARY 2007 5

 Risk Management Process - Response
RISK MANAGEMENT
PLANNING

RISK MANAGEMENT
OCCURRENCE OF MONITORING
RISK EVENT

RISK OCCURRENCE
RESPONSE

DECISION IS DELAYED RESPONSE

TO SITUATION

ACTION TO SPEEDEN DECISION

CONTROL
ACTION TO SUBSTITUTE PROJECT
OF RESPONSE

FOLLOW-UP ON
ACTIONS ASSESSMENT OF
SITUATION POST-EVENT

REVIEW OF PLAN
REVIEW OF RESPONSE

PROJECT jANUARY 2007 6

 Risk components

EXPECTED IMPACT OF
TIME-FRAME
OCCURRENCE

LIKELIHOOD OF POSSIBILITY OF REDUCING DECISION TO TAKE

OCCURRENCE LIKELIHOOD ON RISK

POSSIBILITY OF PLANNED RESPONSE TO

EFFECT OF RISK
COVERAGE EVENTUAL OCCURRENCE

INTENSITY OF EFFECT EXPECTED RESIDUAL RISK

PROJECT jANUARY 2007 7

 Risk components 2

• Likelihood of occurence
Probability Likelihood
• 0% to 1% : highly improbable
• over 1% to 5%: improbable
• over 5% to 20%: eventual
• over 20% to 50%: probable
• over 50% to 100%: highly probable

• Time-frame for this occurence

• within 2 years after investment:
short-term, i.e. there is little time to change risk conditions
• until 8 years after investment:
medium term. i.e. there is some time to change risk conditions

PROJECT jANUARY 2007 8

 Risk components 3
• Effect of risk
• Delay in operations
• Increase in cost
• Loss of revenue
• Loss of assets
• Increase in liabilities

• Intensity of effect
• low
• medium
• high

• Result of occurence
• small: affects standard IRR by less than 1% p.a.
• medium: affects standard IRR by over 1% up to 3% p.a.
• great: affects standard IRR by over 3% up to 5% p.a.
• drastic: affects standard IRR by over 5% p.a.

PROJECT jANUARY 2007 9

 Risk coverage

INSURANCE

HEDGE

MITIGATION OF
EVENTUAL IMPACT

GUARANTEE

OTHER CONTRACTUAL
TRANSFER
ABSORTION OF
RESIDUAL RISK

PROJECT jANUARY 2007 10

 Risk categories combined with results
100 200 400 800 3200 100 200 400 1600

50 100 200 400 1600 50 100 200 800

20 40 80 160 640 20 40 80 320

10 20 40 80 320 10 20 40 160

5 10 20 40 160 5 10 20 80

2 4 8 16 64 2 4 8 32

1 2 4 8 32 1 2 4 16

2 4 8 32 1 2 4 16

Small Medium Great Drastic Small Medium Great Drastic

SHORT TERM MEDIUM TERM

RISK CLASSIFICATION

From 1 to 7 Acceptable
From 8 to 19 Acceptable
From 20 to 31 Acceptable
From 21 to 63 Acceptable
From 64 to 99 Only acceptable if covered
From 100 to 299 Only acceptable if covered
From 300 to 499 Only acceptable if covered
500 or over Not acceptable
PROJECT jANUARY 2007 11
 Decision parameters
• Acceptable risks
• Define risks
• Analyse possible reduction of likelihood and mitigation of impact
• Include cost of these counter-measures in investment analysis

• Risks acceptable only if covered

• Define risks
• Analyse possible reduction of likelihood and mitigation of impact
• Establish coverage (insurance, hedge, security)
• Include cost of these counter-measures and coverage in investment analysis

• Non-acceptable risks
• Define risks
• Analyse if possible counter-measures or coverage can change their classification
• Reject investment if this is not feasible and efficient (investment phase) or
• Take drastic counter-measures or divest operation (after investment phase)

PROJECT jANUARY 2007 12

 Main risks in each phase of Project
• Investment decisions
• Delayed decision
• Competition for each investment
• Unprofitable choice
• Entry into each local business
• Resistance from local groups
• Delay in establishing management procedures and controls
• Operation of each local business
• Technical risks
• Regulatory and tax context
• Management efficiency
• Joint operation of all businesses
• Market fluctuations
• Lack of or reduced synergy among operations
• Divestment of each business
• Market
• Protracted negotiations
• Competition for new investors
• Post-divestment
• Outstanding liabilities

PROJECT jANUARY 2007 13

 Risks in the investment phase
An example

• Risk identification

• Type

• Level

• Likelihood

• Impact

• Time-frame

PROJECT jANUARY 2007 14

 RISK TYPE LEVEL LIKELIHOOD IMPACT TIME-FRAME

Organization
1 Delay in identifying prospects Human factor
1-Project 2-improbable 1-small 3-short-term

Delay and/or non supply of information by

2 Human factor 1-Project 3-eventual 1-small 3-short-term
sellers
Organization
3 Delay in making decision Human factor
1-Project 2-improbable 1-small 3-short-term

Economic
4 Delay in concluding negotiations Human factor
1-Project 3-eventual 2-medium 3-short-term

Economic
5 Back-trading by sellers Human factor
1-Project 4-probable 2-medium 3-short-term

6 Change in country market context Economic 2-Country 5-highly probable 3-great 2-medium-term

7 Change in world market context Economic 3-Organization 5-highly probable 3-great 3-short-term

8 Change in country business context Economic 2-Country 3-eventual 3-great 2-medium-term

9 Change in world business context Economic 3-Organization 3-eventual 3-great 3-short-term

Delay in establishing and executing Organization

10 Human factor
1-Project 2-improbable 1-small 3-short-term
documents
Organization
11 Inclusion of undesirable/incorrect clause Human factor
1-Project 1-highly improbable 2-medium 3-short-term

Regulatory
12 Non delivery of mandatory licenses Human factor
1-Project 2-improbable 2-medium 3-short-term

Regulatory
13 Delay in delivery of mandatory licenses Human factor
1-Project 3-eventual 1-small 3-short-term

Non discovery of unacceptable risks or Organization

14 Human factor
1-Project 2-improbable 4-critical 2-medium-term
liabilities
15 Fraud in delivered information Criminal 1-Project 2-improbable 4-critical 2-medium-term

Resistance from local management / Cultural

16 Human factor
1-Project 4-probable 1-small 3-short-term
labour
PROJECT jANUARY 2007 15
 GUARANTEE
INSURANCE HEDGE RESIDUAL
RISK REDUCING LIKELIHOOD MITIGATION OF IMPACT
POSSIBILITIES POSSIBILITIES
POSSIBILITIE
RISK
S

1 Delay in identifying prospects Pro-active search Simultaneous projects None None None Low
Documentation list
Delay and/or non supply of information Local follow-up
2 Expliciting the requirement
Partial-decision process None None None Medium
by sellers
Expliciting consequences
Simultaneous projects
3 Delay in making decision Project schedule
Partial-decision process
None None None Low

4 Delay in concluding negotiations Project schedule Simultaneous projects None None None Medium
Clear negotiation Simultaneous projects
5 Back-trading by sellers Reputable partners Competitive negotiation
None None None Medium
Analysis parameters with
6 Change in country market context None
expected time-frame average
Country risk Price hedge None Medium
Analysis parameters within
7 Change in world market context None
expected time-frame average
None Price hedge None Low
Sensibility analysis within
8 Change in country business context None
expected parameter range
Country risk Price hedge None Medium
Sensibility analysis within
9 Change in world business context None
expected parameter range
None Price hedge None High

Delay in establishing and executing Competent legal advisors

10 Simultaneous projects None None None Medium
documents Internal review
Competent legal advisors
11 Inclusion of undesirable/incorrect clause Internal review
None None None None Low

Competent legal advisors Contractual obligation to deliver Contractual

12 Non delivery of mandatory licenses Local representatives correct information
None None
obligation
Low
Competent legal advisors Contractual obligation to deliver Contractual
13 Delay in delivery of mandatory licenses Local representatives correct information
None None
obligation
Medium

Non discovery of unacceptable risks or Contractual

14 Comprehensive due dilligence Contractual generic guarantees None None
obligation
Low
liabilities
Contractual obligation to deliver Contractual
15 Fraud in delivered information Comprehensive due dilligence
correct information
None None
obligation
Low
Adequate confidentiality
procedures
Resistance from local management /
16 Winning local management Contractual generic guarantees None None None High
labour Communication program with local
stakeholders

PROJECT jANUARY 2007 16

 List of potential risks 1
• Commercial - Sourcing
• Performance: non delivery of raw materials
• Performance: late delivery of raw materials
• Performance: raw material off specifications
• Change in availability of raw materials

• Commercial - Sales
• Credit: Non-receipt of sales
• Credit: Late receipt of sales
• Performance: non acceptance of products by buyer
• Performance: delay in acceptance of products by buyer
• Performance: raw material off specifications

PROJECT jANUARY 2007 17

 List of potential risks 2
• Commodity markets
• Cost of raw materials

Materials not yet purchased

Materials purchased but not fixed

Materials in inventory
• Sale prices of produced goods

Unsold products

Products sold but not fixed
• Price fluctuations in straight commercial open positions (purchases and sales
unrelated to production)

• Exchange markets
• Exchange rate fluctuation as to investments

investment in USD x earnings in local currencies
• Exchange rate fluctuation in current operations

foreign sales x domestic costs

PROJECT jANUARY 2007 18

 List of potential risks 3
• Agriculture
• Climate – rain
• Water (availability, investment for sourcing, cost)
• Labour (quality, possibility of strikes, cost)
• Agricultural management (quality, availability, cost)

• Industry
• Equipment (unplanned maintenances, delays, costs)
• Supply of equipments (availability, delay, cost)
• Necessity of increasing industrial facilities
• Necessity of changing industrial process
• Labour (quality, possibility of strikes, cost)
• Industrial management (quality, availability, cost)

PROJECT jANUARY 2007 19

 List of potential risks 4
• Logistics
• Availability of transportation vehicles

Third parties

Own investment

Financing for third parties
• Availability of routes
• Availability of storage capacity

Third parties

Own investment

Financing for third parties
• Availability of maritime terminal time
• Availability of ships within required regularity
• Cost of land transportation
• Cost of storage
• Cost of maritime terminal
• Cost of maritime freight

PROJECT jANUARY 2007 20

 List of potential risks 5
• Financial
• Interest rates fluctuations
• Existing and expected bank debts
• Other existing and expected financial debts
• Existing and expected tax liabilities
• Existing and expected labour liabilities

• Management
• Implementation and maintenance of required controls

agriculture, industry, logistics, sales, markets

accounting, taxes, labour

IT infrastructure and hardware
• Implementation and maintenance of reporting process
• Implementation and maintenance of risk management process
• Motivation of local management and labour

PROJECT jANUARY 2007 21

 List of potential risks 6
• Environment
• Existing environmental liabilities (in agriculture, industry and logistics)

known, but not evaluated

evaluated but without payment obligation

evaluated with payment obligation
• Potential environmental liabilities (in agriculture, industry and logistics)
• Environment-related licenses (delays, cost)

• Regulatory risks
• Labour regulations
• Taxes regulations and compliance (on agriculture, industry, logistics, domestics
sales, exports, earnings, assets)
• Accounting regulations and compliance
• Labour relations compliance
• Other regulations compliance

PROJECT jANUARY 2007 22

 List of potential risks 7
• Corporate risks in local operations
• Conflict with previous owners
• Conflict with remaining partners
• Conflict with government
• Conflict with competitors

• Country risks
• General political risk
• Interest rate differential from country rating
• Social turmoil, acts of God
• Countries:

with local operations

sources of raw materials and products

sales markets

• General corporate risks

PROJECT jANUARY 2007 23

 Agenda for a risk management plan 1
• Review and establish parameters for:
• risk identification (list of risks in each phase of Project)
• organizational levels involved
• time-frame
• likelihood of occurrence
• impact (type of effect, monetary and non-monetary consequences)
• levels of risk tolerance (acceptance, acceptance with coverage, rejection)

• Define, for each risk listed:

• the risk
• possible impacts
• how it will be assessed (statistics, market talk, model estimation etc.)
• who will supply basic input, who will carry out analysis
• time-frame for this analysis (daily, weekly, monthly,...)
• process flow of the risk analysis (local level >> country level >> corporate level)
• possible likelihood-reduction strategies
• possible impact mitigation strategies
• initial response plan to eventual occurrence

PROJECT jANUARY 2007 24

 Agenda for a risk management plan 2
• Define documentation on risk management
• For each project, during investment phase
• For each operation, after investment phase
• For each type of occurrence, during life-time of Project

• To be delivered to local management

• To be delivered to country management
• To be delivered to corporate management
• To be delivered to regulators
• To be delivered to investors
• To local authorities

• Define functions/persons responsible for

• Establishment of risk management plan
• Assessment of risks in each project, during investment phase
• Assessment of risks in each operation after investment phase
• Assessment of corporate risks

PROJECT jANUARY 2007 25

 Agenda for a risk management plan 3

• Month 1
• Define persons/functions responsible for the establishment of a Preliminary Risk
Management Plan (valid until First Closing)
• Establish and approve this Preliminary Risk Management Plan

• Months 2 and 3
• Include extract of Preliminary Plan in presentations to possible Investors
• Work on Risk Management Plan for investment process

• After First Closing (or on assurance of go-ahead)

• Establish and approve the Risk Management Plan for the investment process
• Define responsibilities for the execution of the Risk Management Plan during the
investment process
• Organize the means and resources for this execution
• Beginning discussing and drafting the Operational Risk Management Plan

PROJECT jANUARY 2007 26

 Heitor Moura

A RISK MANAGEMENT PLAN

for an investment and trading project

January 2007