ENTERPRISE RISK MANAGEMENT

Assignment
Regulatory Risk
Term - 5
PGDM Program

Submitted to,

Dr. Gajavelli V. S.

Submitted by,

Group – 3
Abhishek Srivastva (08FN004)
Ameesh Sharma (08FN011)
Anoop Kumar (08HR012)

Institute of Management Technology, Nagpur

2008-10
Introduction
Regulatory risk, a term describing the problems arising from new or existing regulations, is now
one of the greatest threats to business, according to a global survey of 230 senior risk managers
by the Economist Intelligence Unit. In the eyes of many corporate leaders, regulatory risk is now
a greater source of concern than country risk, market and credit risk, IT and people risks, or
terrorism and natural disasters.

Definition

The risk associated with the potential for laws related to a given industry, country, or type of
security to change and impact relevant investments. In other words the risk that is due to change
in laws and regulations will materially impact a security, business, sector or market. A change in
laws or regulations made by the government or a regulatory body can increase the costs of
operating a business, reduce the attractiveness of investment and/or change the competitive
landscape.

Another type of regulatory risk would be a change by the government in the amount of margin
that investment accounts are able to have. While this is an unlikely change, if it were to be
changed, the impact on the stock market would be material as this would force investors to either
meet the new margin requirements or sell off their margined positions.

The cost of regulation is rising

Nearly 90% of companies believe that the cost of regulation will rise over the next three years;
36% of them believe it will rise substantially. This is bad news for companies, but also for their
customers who, according to almost two thirds of executives in the survey, will ultimately foot
the bill for compliance. Regulation has other, indirect consequences for business. Thirty-six
percent of executives say that regulation has stifled innovation in their companies. Just under
one-third fear their firms will become uncompetitive with companies operating in less regulated
countries. Executives acknowledge the need for regulation, but the majority believe the benefits
of recent regulations are outweighed by the problems.

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Regulatory risks increase as firms expand overseas

Increased complexity in the international regulatory environment is one of the biggest challenges
facing companies, with regulations in one country potentially having an increased impact on
firms’ global operations. Only 17% of companies are very confident that they are compliant with
regulation in their overseas markets, compared with 40% that are very confident of compliance
in their home markets. Similarly, only one in five companies have high confidence that they are
compliant with international regulations such as Basel II and International Accounting
Standards.

Regulation is a significant deterrent to overseas investment.

Fully 57% of executives in the survey say that their perception of a country’s regulatory burden
has an important or very important impact on decisions to invest, compared with only 4% that
believe it is of low importance. Over one-third of companies have been deterred from investing
in a new market because of regulatory issues. The results have interesting implications for the
US, which is seen by executives as the country where regulatory burdens are increasing most
significantly.

To illustrate investment implications of regulatory risk consider Regulatory Risk scores (on a
scale of 10) for telecoms operating in thirteen markets in the Asia-Pacific region recently
released by a consultancy named Fitch. It analyzed the risk through three major regulatory sub-
categories: Political & Social Policy Risks; Industrial Policy Risks; and Inability of
Ownership/Management to Offset Regulatory Risks. The scores published are summarized in
table 1 below.

Market Score
Malaysia 3.5
Hong Kong 4.5
Singapore 4.6
Philippines 4.9
Taiwan 5
Thailand 5.3

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 China 5.3
New Zealand 5.5
India 5.5
Indonesia 5.9
Australia 6
South Korea 6
Sri Lanka 6.5

Table 1: Regulatory Risk Scores for Telecoms in Asia-Pacific

(Source: http://www.cellular-news.com/story/40902.php)

A high regulatory risk score of 6 or above denotes that the regulatory environment has a
significantly negative impact on the operator's ability to generate free cash flow and in contrast a
low score below 3 denotes a potentially positive impact on free cash flow. As a general guideline
for foreign investors, regulatory considerations typically have a negative or constraining effect
on the firm’s ability to generate free cash flows, and therefore on its overall rating analysis.

Regulatory risks: a global perspective

In addition to shedding light on the costs and consequences of regulation, the survey by the
Economist Intelligence Unit also reveals the countries where regulatory tightening is having the
greatest impact on business. Topping this list by a huge margin, the US stands out as the country
creating the greatest source of regulatory risk for the majority of companies in the survey. Given
that historically business regulation has been relatively light in the US, this result probably
signifies a strong reaction to Sarbanes-Oxley, as well as the importance of the US market to
companies in the survey. Sarbanes- Oxley has been in force for domestic corporations for a year;
foreign-based firms will need to comply with the legislation by the end of 2006. There is then a
big gap between the US and the second-placed country, Germany, which around one-third of
respondents believe imposes a high regulatory burden. The UK and France follow closely. Other
west European markets, Japan, Canada and China raise some concern and, at the bottom of the
ranking, east European countries (excluding Russia) and Latin American ones are perceived as
relatively light regulators.

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Regulatory risks and industry sectors

Risk due to compliance and regulations often vary according to the industry. Given below is an
indicative list of regulatory risks and the industry they might affect.
• Corporate governance and internal control - Banking, Media
• Regulatory and compliance risk - Banking, Automotive, Utilities
• Radical greening, sustainability and climate change - Consumer products
• Geopolitical or macroeconomic shocks - Asset management
• Protecting and capturing the value of intellectual property - Life sciences
• Asset exploitation and protection of IP rights - Life sciences, Media
• Economic vulnerability in developing markets - Real estate
• Climate and environmental concerns - Oil and gas
• Privacy and security risks - Telecoms
• Political intervention - Oil and gas, Utilities

E&Y’s Risk Radar

Ernst & Young publishes its ‘risk radar’ annually. It is a simple device that allows corporate to
present a snapshot of the top ten business risks across eleven industry sectors worldwide. ,
According to risk radars this year, regulatory and compliance risk is the greatest strategic
challenge facing global businesses in 2009. For the year 2008, it was rated at the top as number
one.

Managing Regulatory Risk

For effective management of regulatory risk companies must adopt a proactive stance.
Regulatory risks are usually narrowly defined and technical, and there are few experts in these
areas within most organizations. Hence there is a tendency for companies to be reactive to these
risks. Regulations often result in certain companies being treated unequally, hence companies
must prioritize this risk appropriately. In sectors characterized by a high degree of regulatory
uncertainty, value may be created by undertaking detailed analysis of future regulatory scenarios

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and preparing detailed plans of engagement with regulatory authorities to influence policy
outcomes.

Conclusion

The tension between corporate self-discipline and state regulation is as active as ever. In a
globalised economy awash with financial flows and dominated by multinational conglomerates,
the stakes are also extremely high. For risk managers, navigating through this period of change is
a formidable challenge, and one that must be achieved without detracting from the task of
monitoring and mitigating a multitude of other risks that fall under the remit of the CRO. In this
regard, an integrated approach to risk management is especially crucial.

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