Enterprise Risk Management (ERM) in an organization includes the business processes and methods used to identify and manage risks as well as seize upside opportunities to achieve its objectives. ERM, therefore, provides a specific methodological framework in risk management for identifying risky events or conditions relevant to the organization’s objectives, risks, and opportunities, identifying and assessing these conditions in terms of Likelihood or frequency of occurrence as well as the risk condition’s magnitude of Impact, determining risk mitigation and post risk response strategy, and monitoring the progress of these risk controls. When organizations identify and proactively address risks and opportunities, they are able to protect and create value for their stakeholders (e.g., owners, employees, shareholders, executives, customers, regulators, nations, and society in general).
ERM is also commonly described as a risk-based approach for strategic planning as well as for managing an organization by integrating internal risk controls and external risk-compliance requirements (e.g., COSO, ISO 31000:2009, Basel III, and Sarbanes–Oxley Act). It applies to a broad spectrum of risks facing an organization to ensure that these risks are properly identified and managed. Investors, government regulators, banks, and debt rating agencies, among others, tend to scrutinize the risk-management processes of an organization as a key metric to its potential success.
In addition, the reasons for an organization to implement ERM should, at the very least, include the following areas of concern:
- Alignment of Risk Appetite and Strategy. Senior management typically considers the organization’s risk appetite when strategic investment alternatives are being evaluated, as well as when setting objectives and developing mechanisms to manage risks. This tactic helps the organization to align its risk objectives with its business processes.
- Enhanced Risk-Response Decisions. ERM provides both the qualitative and quantitative rigor to identify and select from among alternative risk responses, including strategic real options and analysis of alternatives for risk avoidance, risk reduction, risk sharing, risk mitigation, and risk acceptance.
- Reduction in Operational Surprises and Losses. Organizations will gain enhanced capabilities to Identify, Assess, Prioritize, Value, Diversify, and Mitigate potential risk events’ losses using advanced quantitative risk analytics. Instead of just qualitatively identifying risks, organizations can translate these qualitativeelements into quantitative risk models where Monte Carlo Risk Simulations, Stochastic Modeling, Portfolio Optimization, Predictive Forecasting, Business Intelligence, and Capital Investment Valuation and Modeling can be performed.
- Identify and Manage Multiple Cross-Enterprise Correlated Risks within a Corporate Portfolio Environment. Every enterprise faces a myriad of risks affecting different parts of the organization. ERM facilitates effective response to these interrelated and correlated impacts and integrates responses to multiple risks. Financial risks and risks in capital investment projects can also be handled within the environment of a correlated portfolio of projects where risks are hedged and diversified.
- Seizing Opportunities. Risks imply uncertainties, and uncertainties carry with them downside risks as well as upside potential. By considering a full range of potential events and risks and creating strategic investment flexibility or strategic real options, management will be positioned to proactively realize upside opportunities, while at the same time mitigate downside risks.
- Improved Capital Robust Quantitative Risk Metrics and Key Performance Indicators (KPI) generated through a comprehensive ERM process will allow management to effectively assess overall capital needs and enhance its capital allocation (e.g., creating an efficient investment portfolio subject to budgetary, schedule, strategic, and other constraints).