Enterprise Risk Management - Applications for Asian Real Estate Investing

Enterprise Risk Management (ERM) is a holistic and constant series of interconnected processes for anticipating, minimizing, and managing enterprise/business wide Risks to manage performance volatility and maximize the core value of the business.

An informed ERM approach involves both the Executive Management and the Board to assess Governance, Policy, sharpen Risk measurement, improve Monitoring of key business drivers and design Reporting to ensure timeliness and accuracy of risk incidents as they emerge.

Recent episodes involving high profile cases such as Evergrande, FTX, Adani, Optus, and Silicon Valley Bank’s swift unravelling last week have one element in common – inadequate Risk Management frameworks and a poorer response and Crisis Management playbook.?

In an age when news travels fast, social media pressures exacerbate pressures on stakeholders and public sentiment weighs heavy on lumbering regulatory responses. A comprehensive approach to ERM should be at the core of every Board and Management operating framework and every strategy discussion.

For a global asset class that has ambitions to be considered an enduring core Asset Allocation consideration, private Real Estate needs to spruce up its Transparency, Risk controls and Reporting standards dramatically.?The challenges get more acute as investors seek to deploy incremental capital to fast growing Asian emerging markets where incumbent Institutional frameworks are relatively immature and often constrained by convenient socio-political interventions.

Let’s examine the oft cited absence of some key indicators and operational elements which inhibit a robust application of an informed ERM approach, as applied to the Real Estate investment and Asset Management industry.?For progressive Leadership teams, many of these are easily implemented, and prudently monitored resulting in proven long term beneficial impact on Business Performance. Broadly, these can be grouped under:

A.?????Governance – Oversight, Transparency, and Reporting standards

B.????Operating Philosophy – Diversity, Sustainability, and Incentives

1.?????Independent, Non-Executive oversight

§?Majority of the businesses stuff their Boards and senior Management with handpicked, subservient Directors who owe their appointment and tenure by being friendly to incumbent Executive Management/ CEO or controlling shareholders.?Not surprisingly, this is often at the expense of minority shareholders, co-investors, suppliers, and employees, amongst others.

§?Management led Boards with long tenured Directors is an obvious red flag often associated with businesses where the NAV/ stock price consistently lags Industry and peer group performance benchmarks.?In many cases, there is no evidence of a process that mandates a regular Director performance assessment which forms the basis for reappointment decisions. Similarly, long tenured Internal and External Audit relationships need examination against the weight of performance evidence.

§?Board Committees are few (just enough to satisfy regulatory requirements) and staffed by officers who tend to have a myriad of inherent conflicts of interest. Committees involving Risk, Internal Audit, Compensation, and other such key business influences are either absent or poorly resourced.

§?Boards lack majority number of Independent, Non-Executive Members.

§?CEO and Chair of the Board roles are not segregated.

2.?????Diversity

§?Management and Boards are staffed by family and friends. Hiring at senior, influential levels have no competitive pressure.

§?Global/ Regional organizations with material revenues overseas have an overwhelming tilt of Management and Board constituted by “Home” Directors and/or a uniform racial profile.

§?Critical policy decisions are not Board controlled nor approved and/ or have little input from Independent Directors.

§?Massive gaps in bridging basic Gender, Race, and Compensation Inequity goals.

§?Lack of multifaceted and diversely skilled Board members.

3.?????Sustainability

§?Environmental review is not a mandatory part of each Board agenda.

§?The Investment Committee does not define measurable sustainable outcomes criteria as a qualifying factor for each investment.

§?Risk registers, if present, do not include sustainability related incidents or report with inordinate lags.

§?Financial reporting does not aggressively report impairment or losses due to impact of business operations.

§?Lenders and Equity holders have insufficient information to assess suitability of funding requirements.

4.?????Transparency

§?Financial statements are often delayed and usually presented in a form that makes difficult any timely interventions to improve business performance.

§?Valuations of Investment holdings and Fixed Assets that lag market impact.?Both under reporting and inflated valuations are detrimental to shareholders.

§?Infrequent Board meetings, regular absentee Directors, verbal discussions with very few written memos for review, no Board dissent, infrequent strategic? reviews, archaic Risk appetite statements and Crisis Management plans – all signs of malaise in managing Risk appropriately.

5.?????Reporting

§?Fraudulent or misleading Claims made on important ESG impact issues – Fairness & Equity, Workplace Safety & Culture, Decarbonization efforts,

§?Infrequent stress tests for Intangibles, Asset?Valuation, Land inventories, etc.

§?Lack of comparative management data for industry and peer group benchmark reviews.

§?Delayed information on material events, for e.g.; resignation of key personnel, safety incidents, adverse covenants demanded by Lenders, sexual harassment allegations.

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6.?????Incentives

§?At risk compensation components which are relatively immaterial as compared to total renumeration.

§?Concentration of bulk of rewards for a few key executives.

§?Front loaded compensation qualifications not linked to long term growth of NAV.

§?Wide disparity between skill and remuneration standards across product and business segments, and gender, racial biases.

Businesses that stand the test of time and take industry leadership positions are strongly founded on high ethical and moral standards.?Such industry businesses are good community citizens, involve every stakeholder with confidence and are excellent fiduciaries to those who fund and serve their business interests.?Unsurprisingly, back tested data also shows that these businesses return above industry returns over the long term.

It is well-nigh impossible to operate and excel at peak standards without a comprehensive Enterprise-wide Risk Management program that is instituted in every business function and decision-making process at all levels of the organisation.?As global capital flows turn increasingly favourable for Asian real estate, the industry will serve its interests well by upping its standards and demanding more proactive measures from everyone in the value chain.

Views expressed are personal.