Ratings agencies Eye ERM for all industries.

• Author: Maxwell, James
• Position: RISK MANAGEMENT - Enterprise risk management - Statistical table

In an effort to improve the overall quality of the credit rating process by broadening the scope of their analyses, the major credit ratings agencies are planning to incorporate an entity's enterprise risk management (ERM) activities as an explicit component of their ratings methodology. While this will come as no surprise in the financial services sector, where the agencies began using such evaluations as part of their ratings metrics as early as 2003, other industries will begin to be subject to these new analytics this year.

While the ratings agencies' intent in this area is unambiguous, it is potentially seismic--both in terms of the investment organizations may need to make in developing their ERM capabilities and in terms of what's at stake. Standard & Poor's (S & P), for instance, has said that changes in ERM assessments, good or bad, will drive ratings and outlook changes.

Agencies have been transparent about the criteria they apply to the financial services sector, and are now seeking to adapt these criteria as they expand this approach to non-financial organizations. As an example, Standard & Poor's is currently inviting comment from interested parties on its proposed approach to ERM analysis for non-financial companies. It recently stated:

"We now propose to introduce Enterprise Risk Management (ERM) analysis into the corporate credit ratings process globally as a forward-looking, structured frame-work to evaluate management as a principal component in determining the overall business profile." (The business profile, along with the financial profile, is one of the key factors of an S & P credit rating.)

The request for comment was scheduled to run through the end of February, and S & P expects to have decided by March 1 whether to go ahead and include evaluation of ERM in its rating methodology for corporate entities. In addition, S & P is actively communicating its intentions to interested parties through face-to-face meetings and seminars.

Similarly, Moody's Investors Service has been working to further develop consideration of ERM as a component of its ratings methodology, through its Enhanced Analysis Initiative and by means of formal Risk Management Assessments, building on the work it has been doing with insurers and banks. The latter focus has been on firms that have a significant exposure to financial, commodity or energy risk.

Agencies Moving Cautiously

It's important to note, however, that the agencies are proceeding cautiously. The benefit (and threat) to their ratings process through explicit inclusion of ERM is still subject to some debate, and there are a number of logistical...