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GOVERNANCE

The financial scandals of the mid-1990s, such as Barings Bank and Orange County, were just as troubling then as the recent decade's risk management mistakes, misdeeds, and failures are to today's regulators and investors. The financial culprit then was the emerging issue of financial derivatives rather than the residential mortgage-backed securities that wreaked havoc on the global financial markets in 2008-2009. The scandals of the 1990s had the effect of sensitizing legislators, regulators, and investor advocates to start asking organizations questions about how publicly traded companies manage the inherent risks of their business. From these concerns were born a number of guidelines and standards in many parts of the world that, in general, allocated accountability to directors, officers, and organizational management to effectively manage their risks. One example, corporate governance guidelines produced by the Toronto Stock Exchange (TSX), set out five general responsibilities of directors in Canada. In addition to strategic planning, succession planning, communication policy, and internal control/management systems, directors were given responsibility for "the identification of the principal risks of the corporation's business and ensuring the implementation of appropriate systems to manage those risks."[1]

For a company historically sensitized to managing substantial business risks, particularly grain price volatility,[2] the TSX guidelines immediately struck a chord. The board of directors of UGG therefore mandated the chief executive officer to form a Risk Management Committee, establish a formal risk management policy, develop corporate-wide risk management processes, and report to the Audit Committee of the board of directors on a quarterly basis. The board of UGG created a platform for the adoption of ERM and a strategic approach to risk management.

UGG already had a solid platform on which to build its approach to ERM. Risk management was a process that was well ingrained at UGG, and had been since the 1970s. The organization had a risk management policy, applied risk management processes via inspections (identification and evaluation) as required under its corporate insurance programs, and had developed internal loss prevention programs (environment, safety, and loss control); but, unlike many other organizations at the time, UGG also applied a risk measurement metric to its risk management initiatives by tracking its "cost of risk" (net risk retention costs + risk transfer costs + risk-related administrative overhead = cost of risk).

Concurrently, UGG's leadership team was wringing out as much cost from the system as possible. Between the capital requirements for the new elevators, a lengthy depressed operating environment, and reduced crop volumes, reducing cost throughout UGG was a critical objective. Risk management expenses were no exception.

  • [1] In 1994 a committee sponsored by the TSX published a report (the Dey Report) containing corporate governance recommendations to TSX-listed companies. In 1995 the TSX adopted them as "best practice guidelines." Although the guidelines were not mandatory, the TSX did require listed companies to disclose annually their approach to corporate governance and provide an explanation of any differences from the guidelines.
  • [2] Virtually all grain purchases not matched by sales contracts, as well as sales contracts for which the company did not have purchased grain, were hedged using derivatives on long-established international grain exchanges, while very limited, unhedged positions had been closely managed and supervised for many years.
 
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