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CFOs, Corporate financing and Integrated Reporting under Solvency By Dr Pascal LELE (PhD), Dr Simon Grima (PhD) and Frank Bezzina (PhD) (“E-learning Forum Solvency” working paper)

Abstract

The impact of Solvency requirements, Basel III and integrated reporting on the financing of listed companies and SMEs should not be as hard as said ... especially if you have the right tools to complement the existing.

Since the subprime crisis, the job of the CFO has changed more than that of any other corporate executive. So far, CFOs were almost exclusively preoccupied with raising and controlling capital movements. The new Financial Services Regulations such as laws of Basel III, NAIC (US solvency) and Solvency II require the CFOs to interrelate strategy with the cash generating units (CGU), the risk appetite and tolerance threshold of the Board of Directors on behalf of the shareholders. This makes them also responsible for monitoring the employment and profitability of HR and IT system as a means of value creation and Integrated Reporting (IR).

Basel II and its impact on the IT tools

Further the recommendations made by the Bank of Settlements (BIS) in Basel II, risk were treated in 4 ways: Avoid (should never occur); Reduce (decrease its potentiality or impact); transfer (to the insurer) or Accept (if it is within the appetite and tolerance of the firm).

Companies had set up two types of solutions.

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Upstream, software of risks cartography or risks register. Whether the approach is as they say "top-down" or "bottom-up" in both cases, the risk manager organizes the risk library.

The major publishers are TMA, Plan424, MetricStream, RiskNav®, Risk Matrix, SAP, Oracle etc. and, •

Downstream, integrated business intelligence solutions and reporting tools.

The main platforms of this type are IBM, SAP, Enablon, SAS, Microsoft, MicroStrategy, Oracle, etc.

The problem changes with clause 5 of ISO 31000 (Risk Treatment) and Enterprise Risk Management used in the ORSA/FLAOR process. This change reveals the lack of IT tools and automation to help in the real-time interactions of the internal control functions. Solvency II requires the CFOs of insurance companies to determine the operational risk to a 95.5% confidence level and to maintain capital as a buffer for this risk. This requires CFOs to maintain a level of operational risk management "best practice" in general, whatever their field of activity or the regulatory framework in which they operate: -

Operational risks should be aligned to the tolerance threshold and appetite of the shareholders.

The missing link of IT for Solvency The problem changes with clause 5 of ISO 31000 (Risk Treatment) and ERM focused on ORSA process. This forces to involve all HR in cost accounting based on expected losses (EL) approach or loss of tolerance threshold ("Risk Appetite") to take into account the

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operational risk data associated with a counterparty credit risk (CCR) and also the interdependence of risks.

For the CFO of insurance companies, in addition to those requirements that strengthen cash savings of operational risk costs to a 95.5% confidence level and to provide the actuaries modeling data of " Risks, Opportunities and Results "(pillar 3). The insured risk transfer; to reduce the cost of the premium (or contribution), the insurer's customers (banks, SMEs, large companies and administrations of the state) have an incentive to align their tolerance of operational risk losses (risk appetite) on "best practice" of the insurer (See “Solvency II and NAIC (US Solvency), banks and CFOs: what changes?”)

Accounting treatment upstream

Upstream, it is therefore to recover the risk event data stored by the risk map. And treat them according to a known equation ("Solvency II, banks and CFO: what is changing?" Objective of the accounting treatment: provide interaction data of internal control functions and measuring gaps in real time.

The known solution, IT-IRM allows doing this.

Figure 1—IT-directed IRM’s Corporate Interactions of the Value Creation Plan (Intranet)

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Source: Riskosoft Corporation. Reprinted with permission

System security is based on the non-direct access from client to server and non communication of data by email. Downstream, the IT-IRM platform provides the cost saving actual data for updating the risk profile, internal ratings, credit policies and calculation of insurance premium rates, particularly when the financial and social quality of the company (or counterparty risk) is deteriorating.

The internal model (Intranet) obtained by the application interconnectivity is this: Figure 2/ Interfacing scheme supplementing existing IT by the IT-IRM missing link Risk Data Collection

Risk Treatment

Forward-looking Provisioning Scenarios

Integrated Reporting (IR)

Internal data bases interfaced by IT-IRM

Mapping or risk register

IT-IRM (Investor Relationship Management)

Stochastic calculations

XBRT or XBRL

Source: Riskosoft Corporation. Reprinted with permission

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Expected impact on economic capital, variable pay and solvency The operational loss data collected indicators for almost 40 years by the socio-economic analysis in 32 countries on 5 continents have established sectoral average losses: •

Industry and Services: 89% of payroll, or $ 21,285 per person per year;

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Banking and insurance: 45% of payroll per person, or $ 18,000 per year.

By aligning its level of operational risk costs on the economy "best practice" defined by Solvency II to 95.5%, every business industry and services sectors, for example, plans for three years save an average of 20 327, $ 17 per employee, 67% of which reinforces the economic capital (13 $ 619.20) and 33% variable pay of each employee (6 $ 707.96) without having to allocate the share on net income for the year paying ROI (Return on Investment).

This has probably convinced you.

You need to know only one publisher, RISKOSOFT company has anticipated this development and build the cost accounting Intranet whose model is known from the article published in the US by ISACA Journal, "The Value in using IT-directed Investor Relationship Management".

The E-learning Development Intersector Professional Forum (Banking, Insurance, Industry and Services including municipal services) initiated by the EU-US Working Group on ERM, the IT-IRM leader Riskosoft, in association with universities, professional associations and risk management magazines, are developing an International Certificate of Operational Risk Manager Specialized Solvency (ICORMSS), which should facilitate and speed up the implementation of the requirements of ERM ORSA / FLAOR integrated reporting and Pillar 3 by the stakeholders. AUTHORS Dr Pascal LELE (PhD) - With a multidisciplinary training (two doctorates from French universities René Descartes and Sorbonne and PhD from the University of Laval of Canada), Pascal Lélé works for more than 10 years the accounting and psycho-sociologic foundations of the internal model required to automate in real time interaction of internal control functions of the financial performance of ERM (Enterprise Risk Management) based on the "Direct costing" (or "Contributing costing"), taking into account the HR predominant effect on operational risk losses. His publications include the book "After the subprime crisis, the new social partnership" (Editions Peterlang, Switzerland, 2009). He is the Director of Research, Development and Partnerships of Riskosoft. He can be reached at [email protected].

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6 Dr Simon Grima (PhD) - Head of Insurance Department at University of Malta responsible for the degree in Insurance and Risk Management. Dr Simon Grima is the outgoing president of the Malta Association of Risk Management and now the Chairman of the Education Scientific Committee of PRIMO Europe. PRIMO is established with the aim of advancing the knowledge and use of Risk Management within the local governmental sector, as well as the public sector at large, in Europe. To achieve this purpose PRIMO Europe provides a comprehensive web library with RISK MANAGEMENT information, newsletters, education and conferences. He has held/holds various positions within Financial Services industry over the past 30 years. He can be reached at [email protected] .

Dr Frank Bezzina (PhD) - is the head of the Department of Management and deputy dean of the Faculty of Economics, Management and Accountancy at the University of Malta. . He teaches Managerial Decision Modeling, Quantitative Research Methods, Operations Research, and Decision & Risk Analysis on the Faculty’s degree and MBA (Executive) programs. He can be reached at [email protected]

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