Risk management at Royal Dutch Shell

Risks of Royal Dutch Shell Plc.

๏ capital market risk

๏ market risk:

๏ interest rate risk

๏ foreign exchange rate risk

๏ price risk

๏ credit risk

๏ liquidity risk

๏ country risk

๏ environment risk

๏ health, safety and security risk

๏ political risk

๏ property and liability risk

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Financial risks Other risks

๏ the risk that the capital of the company can lose value, generally caused by fluctuation in security prices

๏ the volatility in the capital markets affects the investment performance, which in turn affect the funding of future liabilities

๏ it could be also associated with the capital market systematic risk, that cannot be diversified

Capital market risk

Market risk

๏ the risk of possible losses arising from movements in market prices, these are mainly due to fluctuation in:

๏ interest rate

๏ foreign exchange

๏ prices

Credit risk

๏ the risk of a loss that arises when the counter party do not repay on a certain date

Liquidity risk

๏ the probability of loss generated by the inability of the company to meet its debt obligations

Country risk๏ this risk includes all the risks

generated by the investment in a foreign country. It could be associated with the different factors:

๏ economic

๏ politic

๏ social

Political risk

๏ the risk of possible negative effects that political changes or instability in a country could have on the company

Property and liability risk๏ the risk that the property

is damaged or destroyed by a peril, while the liability risk is the threat of the company having to bear the consequences of damage or breaching standards

๏ these kinds of risk include also the risk arising as a result of unforeseen events or liabilities

Environmental risk

๏ threat of adverse effects arising from the outside environment of an organization's activities (by effluents, emissions, wastes, resource depletion)

Health, safety and security risk

๏ these risks include the risks related to put in danger the health, safety and security of the workers (exposure to dangerous substances, risk of injury)

Risk management tools๏ treasury standards

๏ insurance and derivatives instruments (futures, options, commodity swaps)

๏ regular review of individual credit limits

๏ forward foreign exchange contracts

๏ raise of external debt and repayment programs

๏ certification (ISO 14001), awareness campaign to promote fuel saving driving habits (HSSE risk)

Steps to reduce risk exposure

๏ detailed credit analysis and continuos monitoring of trading partners

๏ limiting large volume trade with highest-rated counterparties

๏ shortening exposure duration

๏ taking collateral

Why subsidiaries are not allowed to deal in derivatives instruments?

Shell has a special Treasury structured by group level specialist regional organizations and specialist of oil and gas trading who deal with derivatives instruments.

this could be mainly due to a centralization policy. “For example, different parts of the business involved in treasury will frequently have different systems and different ways of recording and reporting information. This can mean that it can take a long time to construct a global cash or risk position when combining information from different sources.”

Source: Woods, Group Vice President, SunGard,2009, p. 24

Jeannot Jonas Director

Global Treasury Operations Goodrich Corporations

“We chose to implement the AvantGard Treasury solution because we wanted to improve visibility into daily cash positions. We also needed to gain a higher degree of

structure surrounding our cash, risk and debt management processes. The solution has thus far met all of our demands

in these areas, providing our treasury with the tools necessary in order to make the best possible business

decisions and ultimately increase revenue.”

Source: Woods, Group Vice President, SunGard,2009, p. 24

Why should the board be responsible and accountable for managing the risk?

the company must be able to identify, measure, control and price all the risks that it faces. This mainly because it is crucial not only for the profitability of the company, but also to its solvency and future survival.

the main purposes of risk management are:

๏ identify possible risks

๏ reduce their impact

๏ provide a basis for the decision making

Source: Resti & Sironi, 2007, XXII

Building a hedging strategy The main aim of a hedging strategy is to identify

and reduce the risk of losses on the capital

Risk management processRisk Tolerances:

๏ Minor: noticeable disruption to results, manageable;

๏ Moderate: material deterioration in results, management response;

๏ Major: significant deterioration in results, management response required;

๏ Severe: fundamental threat to operating results, immediate senior management attention;

๏ Worst Case: results threaten survival of company in current form, potentially full-time senior management response until resolved

Establish the business context and collecting information ๏ strategy ๏ business objectives ๏ risk tolerances ๏ risk owners stakeholders ๏ risk language

Identify risks What and how can happen?

Source: Aabo, Fraser, Simkins, 2005, pp 18-31

Risk management process (2)Assess risks and controlsdetermine consequence

Assess current controlsconfirm

existencedetermine

effectiveness

estimate strength of control

determine likelihood

estimate level of riskSource: Aabo, Fraser, Simkins, 2005, pp 18-31

Risk management process (3)Tolerable risk?

(risk owner)

Source: Aabo, Fraser, Simkins, 2005, pp 18-31

Mitigate/treat risks ๏ identify treatment option ๏ assess effectiveness ๏ assess cost ๏ assess ease of

implementation ๏ prepare/approve

treatment plans ๏ implement plans

Monitoring and assessing risk management performanceyes

no