Quantitative Data-Driven Risk Management and Internal Audit
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THE AUDIT COMMITTEE’S ROLE IN ANTICIPATING AND MANAGING EMERGING RISKS Black swans like the Covid-19 health crisis and the resulting fallout provide salutary lessons on how boards must be prepared for a panoply of risks. This session guides audit comittee members on how to provide an effective oversight on risk management practices in the organisation, without duplicating the efforts from the Risk Management Department and leveraging on internal audit as an effective third line of defence EL PAPEL DEL COMITÉ DE AUDITORÍA EN ANTICIPACIÓN Y GESTIÓN DE RIESGOS EMERGENTES Los cisnes negros como la crisis de salud de Covid-19 y las consecuencias resultantes brindan lecciones saludables sobre cómo las juntas deben estar preparadas para una panoplia de riesgos. Esta sesión guía a los miembros del comité de auditoría sobre cómo proporcionar una visión general eficaz de las prácticas de gestión de riesgos en la organización, sin duplicar los esfuerzos del Departamento de Gestión de Riesgos y aprovechando la auditoría interna como una tercera línea de defensa eficaz.
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Quantitative Data-Driven Risk Management and Internal Audit
- 4. PANELLISTS MODERATO R THE AUDIT COMMITTEE’S ROLE IN ANTICIPATING AND MANAGING EMERGING RISKS PROF HERNAN HUWYLER Compliance Programme Director IE Business School Denmark SPEAKER
- 5. Board overview trends after COVID19 Scenario planning Resilience risks Risks for move- to-cloud and digitalization strategies Quantified cyber risks Client and supplier solvency risks Decision trees Transformation and cost reduction risks Testing assumptions [5]
- 6. Immature risk techniques Assessing risks in red, yellow and green is malpractice and negligence Flawed techniques • Heat maps • Risk matrices • Scoring and rating systems Useless Incorrect decision- making Accountability principle Liabilities for • Organizations • Board members • Auditors [6]
- 7. What does the board needs to know about risks? You cannot reply to them talking about colors • Is this price covering the liabilities? • How much should we invest? • Should we set a reserve for incidents? • Are we paying for the right insurance coverage? • Should we outsource? • Are the costs of these controls being recovered? [7]
- 8. What risks should the audit committee cover? You cannot focus the audit plan using colors • Better cash-flow forecasting for impairments and covenants > COVID crisis, COVID risk reporting • Higher fraud risks > work-from- anywhere, segregation when reducing staff • Skill gaps in cyber controls • Reassess the inventory values and costs [8]
- 9. Science proving that red, yellow and green… … DON’T work What is wrong about risk matrices, Tony Cox, 2008 > worse than useless Further thoughts on the utility of risk matrices, David Ball, 2013 > untrustworthy picture Risk matrix input data biases, Erik Smith, 2009 > not objective number grids Some extensions on risk matrix approach, Huihui Ni, 2010 > defects still left unresolved On the origin of probability consequence diagrams, Ben Ale, 2015 > single factor impacts Problems with scoring methods and ordinal scales, Doug Hubbard, 2010 > arbitrary features of the scoring Recommendations on the use and design of risk matrices, Niels Duijm, 2015 > aggregation is problematical Back to Basics: Risk Matrices and ALARP, Glen Wilkinson, 2010 > unable to compare risks … a long list [9]
- 10. Science proving that red, yellow and green… … work [10]
- 11. Monte Carlo Simulations Extract key assumptions used on • Business plans • Budgets • Bids Improve the used planning models to analyze the volatility on the assumptions Run +10,000 random simulations Analyze results • Histograms • Loss exceedance curves • Tornado charts [11]
- 12. Monte Carlo Simulations Planning assumptions Volatility Sales 1,000 90% sure between 800 to 1,100 - Variable costs (600) 80% sure between 450 to 800 - Fixed costs (300) 95% sure between 280 to 320 Profit 100 [12]
- 13. Monte Carlo Simulations 800 1,100 # cases 90% cases 450 800 # cases 80% cases Sales Variable costs Fixed costs 280 320 # cases 95% cases Plan 1,000 [13] Plan 600 Plan 300
- 14. Monte Carlo Simulations Sales 800 1,100 # cases 90% cases Ln (Max) + Ln (Min) 2 Standard Error P(A), μ = , σ = Single Loss [14] = Ln Ln (Max) - Ln (Min) Confidence Interval Standard Error 80% 2.56 90% 3.29 95% 3.92 99% 5.15
- 15. 1400 1200 1000 800 600 1 346 691 1036 1381 1726 2071 2416 2761 3106 3451 3796 4141 4486 4831 5176 5521 5866 6211 6556 6901 7246 7591 7936 8281 8626 8971 9316 9661 Monte Carlo Simulations Sales 800 1,100 # cases 90% cases +LOGNORM.INV(RAND(),(LN(800)+LN(1 100))/2,(LN(1100)-LN(800))/3.29) Plan 1000, 75.1% [15]
- 16. Monte Carlo Simulations 1200 1000 800 600 400 200 1 335 669 1003 1337 1671 2005 2339 2673 3007 3341 3675 4009 4343 4677 5011 5345 5679 6013 6347 6681 7015 7349 7683 8017 8351 8685 9019 9353 9687 450 800 # cases 80% cases Variable costs +LOGNORM.INV(RAND(),(LN(450)+LN(8 00))/2,(LN(800)-LN(450))/2.56) Plan 600, 2% [16]
- 17. Monte Carlo Simulations 280 320 250 290 270 310 350 330 1 324 647 970 1293 1616 1939 2262 2585 2908 3231 3554 3877 4200 4523 4846 5169 5492 5815 6138 6461 6784 7107 7430 7753 8076 8399 8722 9045 9368 9691 # cases 95% cases Variable costs +LOGNORM.INV(RAND(),(LN(280)+LN(3 20))/2,(LN(320)-LN(280))/3. 92) Plan 300, 57.8% [17]
- 18. Loss Exceedance Curve -1000 -800 0 -200 -400 -600 200 600 400 1 224 447 670 893 1116 1339 1562 1785 2008 2231 2454 2677 2900 3123 3346 3569 3792 4015 4238 4461 4684 4907 5130 5353 5576 5799 6022 6245 6468 6691 6914 7137 7360 7583 7806 8029 8252 8475 8698 8921 9144 9367 9590 9813 Plan 100, 98% Plan has 98% chances to fail [18]
- 19. Tornado Chart Sales Variable costs Fixed costs [19] +600 -800 Key: ensure the efficiency of controls reducing variables costs
- 20. How to audit assumptions? [20] • Was the trend data traceable to internal and external objective sources? • Was the trend data approved by an independent expert? • Were risk data and formulas manipulated? • Were expert estimates calibrated and more than 6? • Was any change in the methodology affecting consistency with previous analysis? • Were the lessons learnt incorporated to improve the assumptions? • Was the performance measured and compared to goals?
- 21. How to assess emerging risks? [21] • Weak signals of a newly or rapidly increasing high risk • Predict new threats scanning the horizon • Assessed by performing a business case • Potential disputes with external auditors • Misreporting non- financial information • Failure in digitalization • Tax increases • Restart postponed projects
- 22. OnRisk A Guide to Understanding, Aligning, and Optimizing Risk Institute of Internal Auditors [22]
- 24. Share your success Institute of Internal Auditors https://global.theiia.org https://iiam.com.my/ @TheIIA @IIAMalaysia [24]