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By DOUGLAS MCLEOD and CYRIL TUOHY

At Auburn Hills, Mich.-based BorgWarner Inc., enterprise risk management has brought a changed focus on risk throughout the organization, from the board of directors down, said Brian Maturi, the automotive systems manufacturer's director of risk management.

BorgWarner operates six business units, producing drivetrain, ignition, emissions and cooling systems along with turbochargers and other products. Before the company began its enterprise risk management push with the help of Aon Consulting Services two years ago, "we weren't truly aware of how different we are from one unit to another," Maturi said.

As part of the process, Maturi and BorgWarner managers identified the company's top 25 risks, determined who was responsible for them and what gaps might exist in managing them.

For each of the 25, they asked what factors drive the risks, what systems should be in place to manage them and what metrics should be used to measure whether the risk is under control.

"We've done that for every one of the 25 items we identified," he said.

One of these was the risk associated with plant capacity management. The review included assessing how much capacity was needed for the company's products, whether it was being used effectively and whether business units were prepared to deal with capacity at the end of a given product's life cycle. Managers focused on how well they understood their customers' needs and how good they were at predicting future demand, Maturi said.

The process revealed gaps in the company's understanding and management of its exposures. "We were sitting here all smug and happy, thinking that everything was OK, but when we actually started digging in, we found it was very spotty," he said.

Enterprise risk management has contributed to "the elevation within the company of the risk management function," he said, pointing out that BorgWarner's board of directors "are very keenly interested" in the progress of enterprise risk management efforts.

"The risk management function itself is becoming much broader," said Maturi, who manages BorgWarner's commodity and currency risks along with his other duties.

Commodity risk has become a bigger concern for the company with volatility in the prices of aluminum, copper and other base metals used in manufacturing.

Speculation and the expanded role of hedge funds in commodity markets have contributed to this volatility and forced companies like BorgWarner to look at mechanisms for controlling the risk, he said.

One method is to hedge the commodity exposure using derivative contracts, though a 1998 rule adopted by the Financial Accounting Standards Board can make this difficult for an industrial company like BorgWarner, Maturi said.

Primary producers of, say, aluminum castings have an easier time with the rules, which require a correlation within a defined range between the value of the commodity and its hedging instrument. If the requirement is met, a company can use hedge accounting rules, which allow it to defer gains or losses on the commodity until a product is sold.

Further up the manufacturing chain, it gets more difficult to establish the correlation, and the inability to use hedge accounting can mean that volatile commodity prices lead to volatile earnings, he said.

Aside from hedging, commodity exposure could be managed by simply passing along any increased cost to customers--not always an easy option--or by replacing metal parts with plastic or other materials, removing commodity volatility from the equation, he said.

BorgWarner draws about 75 percent of its revenue from sales in Europe and Asia, and has extensive overseas manufacturing operations. "One of the things we've always tried to do is set up manufacturing facilities in regions where our products are consumed," Maturi said.

This has several advantages, including providing a "natural" currency hedge, especially valuable with the current unpredictability of global economic forces.

AND WITHIN THE FINANCIAL SERVICES ENTERPRISE

In St. Paul, Minn., David Seibert, risk management officer for the 25-branch Affinity Plus Federal Credit Union, has spent the past 18 months developing risk matrices for the union's board of directors.

It is a labor of love, quite literally, and for the first time the board of the 330-employee institution has been able to look at risk holistically across eight categories: credit risk; interest rate risk; liquidity risk; concentration risk; strategic risk; operational risk; compliance risk; and reputational risk.

"It's innovative just for a credit union to have an enterprise risk management program," Seibert said, noting that the Affinity Plus enterprise risk management (ERM) program was the only one of its kind among credit unions in the state.

The board has been seeing Seibert's risk reports for about a year, and the board is now in a position to say, where can we afford to take on more risk? When and where the credit union decides to take on more risk is a decision for the board.

Seibert displays the risk visually using "spider diagrams" for each of the eight categories. Within each category, liquidity risk for example, Seibert can show how each of the factors affecting liquidity risk has changed over time. "The board gets a good picture of risk quickly with these diagrams," he said.

Seibert's operations are lean. He works without a staff, and relies primarily in Microsoft Office documents and spreadsheets. For Affinity's board, no matter, it was a big step forward to be able to the see the totality of the exposures to their enterprise.

Seibert said the credit union's commitment to enterprise risk management is open ended, and that it remained an "ongoing process." He said the institution's enterprise risk management program was at a maturity level of three on a five-point scale.

For all the attention paid to enterprise risk management at the board level, Affinity is still most concerned about how to best serve its members rather than obsessing over algorithms, loan-to-value, and debt-to-income ratios.

Algorithms, loan-to-value, and debt-to-income ratios, of course, are traditionally viewed as a banking institution's measures of financial health, and Affinity Plus has senior managers to worry about those.

Down at the teller level, the credit union has given advisers a very high degree of empowerment and autonomy to be able to build a relationship with members. Advisors have the power to manage certificate of deposits, member banking transactions, loans, and direct deposit accounts, and there's less reliance on stringent rules, credit scores and financial ratios.

"All of that, as you can imagine, makes auditors and bank examiners a bit nervous," Seibert said, and that is why they recommended hiring a risk manager and implementing an enterprise risk management program.

"It's a very personal way of banking," Seibert said. "We're bringing the human factor back into banking. This empowerment strategy started about 10 years ago and the decentralization strategy is much more recent. It's a move we called synergy and it was implemented within the past two years."

Giving tellers more autonomy increases the personal touch in banking, which has become commoditized in many other banks. In another sense, though, it has increased the risks, as the auditors have noted.

How much power the bank wants to give to its tellers to deepen the institution's personal and relationship banking is ultimately a question for the board, and for their enterprise risk management program.

September 15, 2011

Copyright 2011© LRP Publications