After any economic downturn it is expected that companies, along with investors, react with some form of aversion to risk. The period just after the recent financial tsunami was no exception and we witnessed this both in the financial markets, with essentially a near halting of IPO's, and in companies' efforts to reassess investments and streamline operations.

But now with the global economy showing signs of relative stability, we are seeing indicators that company risk appetite levels in both Hong Kong and the mainland are not only stabilizing, but increasing as well. Throughout these markets property prices have continued to rise, supported in part by acquisitions made by mainland companies whose core businesses are not in real estate. While this is a positive indicator of a sustained recovery, it is important to keep this tolerance managed within an acceptable range. Recently, some events have drawn attention and triggered questioning whether we are nearing unacceptable levels, e.g., after Sino-Tech International Holdings Ltd, just last month, jumped into the quickly appreciating Hong Kong residential property market. Many of these moves have been reacted to with skepticism by the market and, with good reason, have led observers to question whether some companies are returning to a pattern of taking on too much risk in search of quick financial gains.

While regulators on both sides have taken appropriate action by introducing measures to help stem the influx of speculative companies, it is important that companies themselves address this threat and other similar questions as part of the risk management process.

Most companies have procedures in place to set their risk appetite levels and guide investment decisions accordingly. However, fewer have mechanisms in place to manage situations where risk has reached unacceptable levels - whether caused by a company's desire for higher returns or influenced by market forces that may lead some investments to appear more attractive than they otherwise would be.

These elements of financial risk are critical components addressed through a risk management process and many companies provide some insight into their own processes through their annual reports. In fact, companies in Hong Kong are encouraged to do so through the stock exchange's listing rules, but the degree of detail provided in these annual reports is rather inconsistent. In falling short in this way, many companies are missing a key opportunity to inform interested parties of the policies and measures they have in place to handle risk and address any market concerns.

Put broadly, a risk management framework surrounding investment risks will factor business strategy, stakeholders' expectations and consider resources or skills needed in managing risk exposure to establish risk appetite. After these factors are considered, the process is formalized by documenting the risk appetite and getting approval from the board. A sound risk management process will then be supported by a monitoring or reporting component to provide oversight and determine whether anything has caused a departure from the approved risk appetite policy.

Based on the market reactions to companies engaging in these uncharacteristic real estate investments, it is clear that some companies do not have these risk management practices adequately in place.

Companies that target improving the risk management process by defining their risk appetite will find advantages extend well beyond the current property issue. They are better prepared to react to changes in the marketplace, in part by the ability to make informed investment decisions quickly. A consistent message and approach also helps set a tone of responsibility for the rest of the organization to follow.

Additional clarity through the annual report, or other stakeholder communication, will also embolden stakeholders with the knowledge that the company views the issue as important, leaving them less susceptible to variations in the market. Stakeholders can also benefit from insisting on more transparency over the methods in place and the key results of any ongoing monitoring performed.

As would be expected, some companies have shown themselves to be better than others at implementing and carrying out such a process. This approach by companies and stakeholders to push for better risk management can play an important role in avoiding potential losses. Given the effects we have seen from other recent booms in property markets and their role in the recent global recession, it would be unfortunate for companies and stakeholders not to seek further improvements in how risks, and therefore investments, are managed.

Eric Zegarra is a manager of Business Risk Services at Grant Thornton in Hong Kong, which is a member firm with Grant Thornton International Ltd, one of the world's leading independently-owned and managed accounting and consulting firms. The opinions expressed here are entirely his own.

(HK Edition 04/21/2010 page3)