Managing mining’s many risks

  • Date:01 Nov 2012
  • Type:Company Director Magazine
Tony Featherstone examines the many hurdles faced by mining boards and provides some tips on how directors can overcome them.

Spare a thought for Australia’s resource sector. It faces a perfect storm of falling commodity prices, rising costs, new federal and state government taxes and royalties, more red tape and proposed tougher reporting requirements around the disclosure of reserves and resources.

Then there is the challenge of managing resource projects in emerging nations; greater focus on environmental, social and governance risks; tax changes that make living away from home less attractive for remote workers; and the risk of breaching continuous disclosure rules and facing a shareholder class action.

Growing uncertainty about the global economy adds another layer of risk for mining companies that live or die on the strength of commodity prices. A hard landing in China’s economy, recession in the US, a new crisis in Europe or more civil unrest in North Africa and the Middle East are huge threats for all mining companies because of their effect on commodity prices.

This long list of risks means boards of mining companies, especially mid-sized and smaller ones, should review their risk-management processes or better still, consider the organisation’s ability to adapt to threats, known and unknown, and remain resilient to external shocks. Boards need to know how the organisation would respond if any key risks eventuate.

Sadly, many of the new risks for the resource sector have been imposed by federal and state governments that do not seem to know how to prolong the resources boom and are unable to get out of its way. But as a price-taker with high fixed costs and large capital requirements, the resource sector is more vulnerable to external shocks than most industries and, therefore, needs an adaptive, flexible approach to managing risk at an executive and board level.

For example, directors of an exploration company with a flagship project in West Africa need to know how the organisation would respond to a halving of commodity prices; a civil war or government changes to mining royalties in an African country; a serious environmental problem; or a breach of continuous disclosure rules because the executive team sits on poor drilling results for too long.

A near-term producer needs to know how project economics stack up at sharply lower commodity prices, the extent of funding risks and the company’s ability to meet loan covenants. Infrastructure risks from delays in road, rail or port projects are other considerations.

Most miners consider such risks and try to control them, but how they would respond to them is another matter.

In a volatile, unpredictable global economy, standard risk-management practices at executive and board level almost seem antiquated and insufficient to deal with powerful external shocks that can fatally wound or badly damage companies.

New thinking about risk management involves challenging the executive team to demonstrate their adaptive capability to deal with a range of shocks and maintain organisational resilience in the face of great economic pressure and uncertainty, rather than relying on standard checklists of risks and basic financial modelling.

Natalie Botha, the founder and managing director of business consultancy Janellis Australia, says the resource sector can benefit from strategies used by the heavier-regulated finance and aviation industries.

"Higher regulation has seen some of the largest companies in these sectors work hard to understand their capacity for organisational resilience in the face of great uncertainty or external shocks.

"In some ways, the resource sector has been shielded from this trend because of the strength of the mining boom and still follows a more traditional approach to assessing risks."

Janellis is pioneering the concept of organisational resilience and adaptive capacity based on its work with organisations such as Westpac Banking Corporation, Lend Lease Group, Qantas Airways, Roads and Maritime Services and the NSW State Emergency Service.

The origin of its work was an early project with the Qantas board, which wanted to know how well its executive team had prepared the organisation for a range of potentially catastrophic shocks. The Qantas board’s foresight went well beyond identifying risks and enforcing risk-management controls; it was about understanding the company’s resilience should a shock occur.

"We are seeing more boards asking executive teams about how the organisations would respond to large shocks," says Botha. "In years past, boards would ask for risks to be identified and seek information to test whether risk-management controls were in place and being enforced. Now boards are realising it’s not enough to just identify and mitigate risks. They want leading, rather than lagging, indicators about the organisation’s resilience and how it would respond to a range of potential risks, some of which may not be known."

Botha adds: "Boards are seeking assurances from the management team that the organisation is sufficiently adaptive, from the executive level to the shop floor, to deal with whatever challenges may confront it. This new approach does not replace traditional risk-management practices, but elevates them to a more sophisticated level. It measures organisational resilience and benchmarks it against other companies in the same sector on a global basis."

Janellis’ new thinking on organisational resilience is based on a four-pronged framework: risk, readiness, response and assurance. Measuring each component helps companies assess their resilience, or capacity to bounce back from a particular event and maintain their effectiveness during periods of intense economic pressure or uncertainty.

The risk component of the framework begins with organisations understanding and communicating their risk appetite and identifying emerging threats, catastrophic risk-management plans, contingency planning and scenario-based modelling of how a particular risk, or convergence of risks, would affect the organisation.

The readiness indicators assess the plans, processes, facilities and tools that ensure the organisation is proactive in managing a negative event. The response indicators assess the capability of teams as they manage through particular events. The assurance indicators assess the reporting, audit and confidence levels of employees, executive teams, boards and other stakeholders in the process.

Janellis’ tool seems a good fit in the resource sector, where boards need to understand and measure the capacity of the organisation to manage through periods of significant change and crisis. But this sophisticated process is more likely to appeal to larger multinational resource companies that face complex risks, than mid-size resource companies with a single project in production, or small miners that face mostly exploration risks.

Simon Gray, the national leader of energy and resources at accounting group Grant Thornton, says mid-sized resource companies face the greatest risks in this market.

"The big miners have relatively good risk models and very small explorers have an ability to operate on an almost care-and-maintenance approach when there are cash constraints or other risks emerge. It’s the miners in the middle that have moved very quickly from explorer to producer that face the biggest risks."

Gray says the risk-management processes and capabilities of mid-sized miners often lag behind their exploration success.

"You often find their ‘back office’ has not caught up with the front end of the organisation, which has developed a mine and may be on the way to becoming a significant producer. Many mid-sized companies have higher costs and greater capital requirements, and thus less scope to wind back the operation until more favourable mining conditions re-emerge."

Gray adds: "You can understand a tiny mining company that has a few million dollars of capital to spend on exploration having a three-member board and fairly rudimentary governance and risk-management processes. It does not need a sophisticated governance structure early on. What you want to see is the governance process rapidly becoming more sophisticated as the company grows."

Gray says poor board composition or a lack of director renewal compounds the governance challenges.

"It depends on where resource companies sit on the curve of size and sophistication. The big-end-of-town miners have very good governance processes and risk-management strategies. But all too often in mid-sized or smaller mining companies, the board ends up being a ‘mates club’ and lacks the right skills to govern the organisation well and understand its specific risks."

For example, an Africa-focused explorer should have at least one director who deeply understands the challenges of working in emerging nations and the political situation.

However, Gray says: "You often find in smaller resource companies that the board consists of the promoter, the geologist and lawyer, and that the board’s composition can stay the same for many years, even though the company is now in production and needs a different skill set among directors. There is not enough board renewal."

He believes part of the problem is directors not doing enough due diligence when joining boards of small miners.

"I have a few mining clients who are looking for new directors and as the auditor, I have made myself available to answer any questions from prospective directors as part of their due-diligence process. So far, I have not had a single inquiry on this matter. It’s surprising that some directors in the mining sector take on board roles with limited due diligence. They should make a bigger effort to understand the company and its culture, and document their due-diligence process."

Gray adds that a culture of disclosure and transparency in small and mid-cap mining companies is vital in good and bad markets.

"You sometimes see smaller mining companies eagerly promote their activities in boom markets, but go to ground in bad markets. Good governance is about having full disclosure and transparency in good and bad times, and building credibility with stakeholders."

Risky business

Company Director asked HopgoodGanim partners Michele Muscillo and Michelle Eastwell about governance issues facing the resource sector. Here are their responses:

Company Director (CD): What are some of the key current and looming governance challenges faced by directors of mining boards?

Michele Muscillo (MM): As commodity prices fall and revenue may not match forecasts, it’s crucial for directors to ensure continuous disclosure of changes in their production profile. In a climate of class actions and increased regulator vigilance, all directors need to make appropriate disclosure early and keep the market informed of interim guidance, rather than waiting for the end-of-year results.

CD: Are mining boards prepared for a downturn in the mining cycle, given that commodity prices are coming off at a time when massive mining capacity is being installed?

MM: Prudent boards should be re-evaluating the feasibility of projects on an ongoing basis and be prepared to make some tough decisions. While it’s important not to panic, boards need to keep a close eye on project economics throughout the planning, development and commissioning phases. A project that has been approved for expenditure may need to be reassessed in light of potential market movements, even if it means taking a short-term hit to the bottom line.

CD: What regulatory and compliance hurdles do directors of mining boards face?

Michelle Eastwell (ME): Ongoing legislative changes mean directors are becoming increasingly responsible for operational liability.

For example, the Federal Government has recently passed legislation to make company directors personally liable for unpaid super contributions if the company fails to comply with its superannuation guarantee obligations. Also, where company directors personally obtain a PAYG credit for tax withheld by a company, the directors will effectively lose that credit (by way of becoming liable to pay PAYG withholding non-compliance tax) where the company fails to remit the PAYG withholding to the Australian Taxation Office.

Directors and officers also have a duty to ensure they, and their businesses, comply with the safety obligations imposed on them under a number of different occupational health and safety laws. Directors cannot simply rely on a company having a work health and safety policy in place. They need to take positive steps to ensure they have a personal knowledge and understanding of the health and safety issues within the organisation, so that proper control measures can be put in place to avoid or reduce the potential hazards and risks associated with the activities undertaken. These can arise from operational and non-operational activities. Directors need to monitor and review the effectiveness of these control measures. This requires constant vigilance, particularly where a number of people are involved.

Finally, the Australian Securities Exchange (ASX) recently released a consultation paper proposing changes to its Listing Rules, designed to improve the reporting regime for reserves and resources for mining and oil and gas exploration and production companies. For many junior companies, compliance with these amendments, if they are adopted, will require reporting systems to be reviewed, creating additional expense and putting pressure on company resources in challenging economic times.

CD: Why do some mining companies lag behind in the governance stakes?

MM: Often, the quality of the governance practices of boards is a function of the size of the company. A balance is needed between spending significant capital, time and resources on governance, on the one hand, and seeking to create shareholder value on the other. Because most ASX-listed mining companies fall in the junior explorer category, a Rolls-Royce governance structure does not necessarily equal a Rolls-Royce share price.

CD: How can boards of mining companies better meet shareholder expectations?

MM: A lack of communication is a significant barrier to effective shareholder engagement, particularly in smaller mining companies. Many take the view that ASX announcements are merely a promotional tool. However, ASX announcements should be used to keep the market fully informed of the company’s plans and operations, whether the news is good or bad. With effective disclosure comes increased shareholder engagement, which helps mining companies develop trust with their shareholders.

CD: How do mining companies improve the diversity and skills mix on their boards?

MM: It’s important to re-evaluate the mix from time to time. As companies evolve, they will find a different and enhanced set of skills may be required. There is no shortage of talented people looking to join boards, so boards need to be prepared to look outside the usual skill sets to increase diversity.

ME: While most companies have a general diversity policy in place, there is a real need for them to establish measurable diversity objectives and then assess and report on their performance against those objectives. Directors should also push to promote a corporate culture that embraces diversity from the top down. Boards should look to bring into an organisation people from the broadest talent pool, consider engaging independent recruitment consultants and be open and transparent about recruitment and selection processes.

CD: What are the key risks of joining the board of a mining company?

MM: Much has been written about the personal liability that directors face in relation to directors’ duties and financial liability. The forgotten element is that to do their job properly, directors need to invest a significant amount of time in the company. It’s a mistake to assume that all it takes to be a director is to turn up to a few board meetings. Other interests may be affected and may need to take a back seat.

CD: What other advice can you give directors of mining companies?

MM: It’s useful for non-executive directors to regularly visit the company’s operations and talk to a range of people, including operational staff. Seeing a project first hand gives directors a better appreciation of the magnitude of the opportunities and risks associated with the project.