Many shipping companies are reluctant to adopt risk management techniques, but only a few are in the luxurious position to do so. Orestis Schinas explains why and how such strategies can help companies to survive the current miserable market environment
Undoubtedly a shipping company is exposed to a number of different risks. Risks related to operations and technical performance, financial[ds_preview] parameters and regulatory developments are only some that impact the overall performance and standing of a company. In the recent years the shipping industry is adopting risk management strategies, either as a response to an aftermath or due to compliance needs or as a trend and recommended set of best practices, the so-called »lessons learned« from other industries. These strategies affect daily operations and decisions at all levels. However, many shipping companies are »resistant« to this change and they do not change their business models, unless required by regulation or dictated by financiers.
Reasons for the reluctance to adopt risk management techniques
Why are these companies reluctant to adopt risk management techniques and strategies? Pessimists advocate »you cannot teach an old dog new tricks« while pragmatists stand up for the argument »If it ain’t broke, don’t fix it« and optimists subscribe to the concept »things take time«. It is the author’s opinion that shipping companies have to get a proactive stance, adopt risk management as key strategic apparatus and develop customized and efficient tools and techniques for their needs, because of two main facts: risk management has been lately institutionalized as well as internal audit procedures are required and are already well in place. The adoption of risk management measures due to compliance needs is a reactive approach; experience suggests that volitional adoption of risk management strategies leads to an improvement of:
• understanding and implementing of a corporate strategy by managers,
• corporate governance practices,
• management accountability, and
• credit ratings and lower cost of capital in some cases.
As all the above are linked to the financial performance of a company, then successful implementation of risk management strategies leads to lower capital costs, attracts investors’ interest and safeguards better the interests of various stakeholders.
Taking into account the definition and common understanding of risk management, the first task of the management is to identify, to assess and finally to prioritize the various risks. The second task is to define strategies and procedures that minimize, monitor or control the probability and/or the impact of an unfortunate event. So the first question can be formulated: What is the appropriate attitude? To avoid, to transfer, to mitigate, or to accept the risks? There is no universal answer to this question, as risks vary substantially among each other and so does the severity of setbacks and failures.
Managers enjoy the liberty to select their battlefield and it is their task and duty to consider all parameters and determine a strategy with the maximum added value
to the company. They are at the helm, their decisions and actions determine the future of the company. There is no panacea for all corporate ills!
Shipping companies are encountered with many different risks or classes of problems, that can be effortlessly broken down into strategic, regulatory, credit and counterparty, liquidity, financial, market, operational as well as human resources ones.
Obviously these classes of risks suggest only an enterprise risk management (ERM) approach, i. e. a given management approach of identifiable risks and objectives. Anyway, there are various definitions and approaches to ERM, and in some cases there is a regulatory straight jacket, such as the well-known Sarbanes-Oxley Act (SOX), with the official name »Public Company Accounting Reform and Investor Protection Act« or »Corporate and Auditing Accountability and Responsibility Act«. So, how could risk management assist the management of a shipping company encounter the challenges of the currently dire markets? The following examples could be enlightening.
Examples for risks and management approaches
Some firms experience losses resulting from the pursuance of defective or ineffective plans and policies. This is a typical strategic risk issue, as the lack or unsuitability of strategy as well as with any factor hindering the company in implementing its strategy and meeting its stated vision and mission is evidenced. The proposed action by an efficient risk management strategic plan would possibly be the adoption of an appropriate business strategy, while the proposed control measurement would be a process of frequent review by the appropriate board of the top management team. One more similar strategic risk, that could be considered in many cases, addressed with techniques and controlled with monitoring and supervision, is the excess control of the majority shareholders which are limiting the influence of the minorities. The failure of managing this risk could be detrimental, especially when new capital is required.
Another interesting example of risk management is the compliance to existing rules and regulations as well as to emerging ones. Violation of compliance with financial and tax authorities, of environmental laws or regulations may adversely affect the company’s earnings and financial condition, and the discernible action and control would be nothing than implementing procedures (say incorporation in the ISM documentation), timetables, instructions and consequent monitoring, reporting and supervision. That being so, the only option left to manage regulatory compliance risks is to mitigate them, i.e. to develop the required internal and external controls and monitoring processes.
Although the above examples address basic and profound management tasks and goals, in reality most shipping firms are confronted with credit, counterparty and liquidity risks. How can such risks be mitigated? The probability of counterparties not honoring their financial obligations, or the potential decline in vessels market value that leads to loan agreement defaults, or the ability to acquire additional financing is hampered, or the increased indebtedness deteriorates the financial standing of the company – these are some of the related and most commonly faced risks.
Experience from listed companies, other industries and financing practices suggest that the companies should have written instructions and internal assessment processes followed prior to any engagement as well as strict and frequent monitoring of the related indicators. This melts down to more complicated strategies than the obvious ones, such as »agreements with first class charterers« etc., which are easy to say but difficult to accomplish and even harder to secure for a long period. It implies more control points and indicators, more exit plans and exit strategies, more flexibility in the projects and more efficient operations, in few words more preparatory work before any engagement and more scientific objectives-driven daily management processes.
More examples can be presented, such as dealing with markets and bunker processes (market risks), internal and external frauds, resignation of key personnel, loss of company control (operational risks) etc. There are countless examples; many cases of »best practices« and »lessons learned« are reported in the business and academic literature, and it remains for the management to decide how risk management should be implemented. In most cases, the first step is the drafting of an ERM plan, a table that classifies risks before and after confrontation and implementation of the appropriate technique to factor and manage the risks.
So, assume the risk arises from the lack of clear strategy – without a specific procedure for preparing, reporting and monitoring the appropriate business strategy this risk is high. It is like navigating without a compass. After confronting this problem, the risk is reduced as it is monitored and its impact at large foreseeable.
Although not necessarily wrong, many confuse risk management with hedging techniques. A common problem such as the exposure to fluctuating prices (e. g. bunker prices or freight markets), which impose strategic and financial risks, depending on the point of view, is associated with hedging techniques. Hedging might be a solution; it offers stability at a cost and reduces the pressure from various shareholder and stakeholders.
However, hedging demands a thorough implementation strategy, coordination with the appropriate financial houses, training of the key personnel and monitoring procedures in place among other prerequisites in order to become a successful risk management strategy and not one more element of the inherent corporate »gambling« pattern.
The same can be considered for liquidity risks, where equity capital should be raised in favorable market conditions and not the opposite, in order to finance growth and not survival needs.
Conclusion and outlook
Risk management techniques and strategies can assist shipping companies to surpass their previous success records and survive the current miserable market conditions. The recent credit crisis, coupled with the overhang of excessive vessel supply in the shipping market, has created a different landscape for shipping companies to navigate. Companies are currently in a position where they face new challenges to their survival. Effective risk management ensures access to financial sources, and especially to equity markets. As short-term liquidity and long-term capital investment is coupled, few shipping companies can afford the luxury to ignore risk management requirements imposed by financiers.
The good news is that already listed companies have paved the way for a speedy adoption and development of tailor-made systems in shipping, as their experiences and practices are widely disseminated. There is no need to reinvent the wheel but only to apply properly the principles, focus on the problem, and adapt »best practices« and »lessons learned« to the existing management structures.
Prof. Dr. Orestis Schinas
