by John Ludlow, Chief Executive, Airmic
Emerging risks are too often ignored by boards who prefer to focus on easier-to-manage visible ones. Why have emerging risks become so important, and how can businesses turn them into an emerging opportunity, asks chief executive of Airmic John Ludlow.
Businesses have always been vulnerable to emerging risks, but in today’s volatile and uncertain environment, disruption to established businesses is becoming more widespread. Changes in global politics, societal opinion and technological innovation are having a far greater impact on business models than ever before – and at a much faster pace.
The ongoing crisis in Hong Kong is a case in point. More than four months of often violent protests have caused serious disruption and loss of business for many organisations, especially those in transport, hospitality and tourism sectors. The crisis has all the hallmarks of an emerging risk. No one could have predicted the exact pattern of events, but the signs of growing political dissatisfaction had been evident since the Umbrella Revolution in 2014.
And yet the speed with which the crisis escalated and the violent nature of some protests caught many companies off-guard. Disruption may have been unavoidable but businesses that planned for this kind of “realistic worst-case scenario” will have been better prepared and more agile in their response.
Too hard to handle?
The UK Corporate Governance Code, which was introduced by the Financial Reporting Council last year, now requires boards to specifically address emerging risks alongside principal risks in their annual reports, and to explain what procedures are in place to identify, manage and mitigate them.
Despite this, boardrooms are still not paying enough attention to emerging risks, according to Airmic’s research on emerging risks, published in June this year. According to the report, which was produced with professional services firm Marsh & McLennan, businesses tend to focus on visible threats where useful data sets exist and where boards feel they have control. As a result, there is a real danger that emerging risks are being filed in the “too hard” or “less important” folder, leaving businesses highly exposed to changing winds that can fundamentally alter their course.
New and emerging risks have, almost by definition, always existed, so why this call to action now? Since the 2008 financial crisis, businesses have given far more attention to risk management, largely driven by more stringent regulatory scrutiny. However, too often risk management efforts have focused on processes, reporting and analytics.
As important as these things are, they are only the start of good risk management. Process-driven risk management is formulaic and often backwards-looking – it is not designed to respond to today’s fast-changing risk environment, or to factor in unintended consequences or more nebulous risks such as shifts in societal attitudes.
Free your mind
One of the key messages from the Airmic and Marsh report is that managing emerging risks requires an entirely different approach to dealing with traditional risks. Emerging risks are far harder to define, quantify and map. You know they are there but you can’t necessarily see the form they are taking. Furthermore, they are not necessarily new risks – they can also be known risks which take on a different profile or characteristic.
Emerging risks require a more imaginative approach. They are different in nature and businesses must deploy new techniques and new tools to deal with them. Formal assessments and heat maps should be exchanged for structured, creative discussions across business units. Boards and risk professionals need to create space to think the unthinkable and speak the unspeakable.
Brexit is a good example of such a risk. All organisations have Britain’s departure from the EU firmly on their radar – however, it maintains the characteristics of an emerging risk due to the extreme uncertainty and the many unknowns it involves. Some Airmic members report that the uncertainty has been a barrier to getting leadership teams to engage. Others report that while operational planning has been meticulous, getting boards to consider how the broader implications of Brexit – such as political changes and long-term shifts in trade relationships – will impact their business models has been a challenge.
Ultimately, however, corporate culture will be the determining factor in whether a company takes a successful approach to emerging risks – and this is where leadership is key. It is incumbent upon boards to cultivate a climate of curiosity and freedom of thought: challenge and debate must be encouraged at all levels of the organisation.
One common problem is that leadership teams are made up of like-minded people with similar backgrounds, which creates an echo chamber of self-reinforcing opinions. Organisations should therefore prioritise diversity of thought when considering the composition of the boardroom, especially when appointing non-executive directors.
Boards that can recalibrate their thinking to proactively take account of emerging risks will have an edge over their competitors: an emerging risk can also be an emerging opportunity, and those that are better prepared will be best placed to exploit the upside.
As with all good risk management, it is not about avoiding bad events or limiting risk taking. It is about creating a risk-intelligent organisation, where risk is closely linked to strategy and opportunity. But to do this, boards and the risk community must be alert to all possibilities, which requires an open mind and freedom of thinking.
Airmic is the leading UK association for everyone who has a responsibility for risk management and insurance for their organisation. Airmic has over 450 corporate members and more than 1,300 individual members, including company secretaries, finance directors and internal auditors, as well as risk and insurance professionals from all sectors. Airmic supports members through training and research, sharing information, a diverse programme of events, encouraging good practice, and lobbying on subjects that directly affect our members.