Risk Management: We're All in This Together

by Paul Simpson, KPMG Agenda Magazine, 27 January 2012

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topics:
Management Risk Management

tags:
commercial risk financial risk operational risk strategic risk technical risk

Here is a story to make any CFO shudder. The treasury department of a major automotive company, noticing that platinum prices were forecast to rise, tied one of its major suppliers to a long-term, high-volume, fixed-price contract.

Finance managers congratulated themselves on a deal well done, not knowing that, at that very moment, their R&D department was developing a new method of making cars that used a lot less platinum. The end result? A senior finance manager, who had done the sensible thing – on the basis of the information he possessed – paid for this organizational dysfunction with an unwanted early retirement.

John Farrell, a Global Advisory Partner for KPMG in the US who is an expert in risk and compliance, says this story illustrates why the management of risk is too serious and complex to be handled entirely by a chief risk officer.

“Organizations need to realize there are two aspects to risk: control and content. Controlling risk might be a task for a select few in the risk function, but every employee is responsible for the content of a risk and should be able to articulate what they see as a growing risk, confident that their assessment of pending danger will be fed into a process which monitors concerns.”

Magnifying, Multiplying

Gunter Dufey, Professor of Finance at the Michigan Ross School of Business, identifies five major types of risk which can impact companies:

strategic (the risk that plans will fail)
financial (controls might fail)
operational (human error)
commercial (the risk of business interruption)
technical (the risk of assets failing or being damaged)

This categorization is helpfully reassuring, but the insurance giant Swiss Re’s list of significant risks – which includes everything from a warning that skin cancer from sunburn could cost the construction industry billions in damages to the observation that one in three countries has absolutely no plan to deal with bird flu – is an unsettling reminder of just how many variables are involved.

Risks are magnifying and multiplying. In the UK, many companies are struggling to understand how the new Bribery Act will affect their business, especially in developing markets. Systemic risk – be it another economic meltdown or a global pandemic – can keep scenario forecasters fully occupied for the rest of their working lives. There are so many variables that any business’s attempt to assess, manage and control risk might seem doomed.

Dufey says: “There’s an old saying in the risk business that the only perfect hedge is in a Japanese garden. Companies now must deal with risks – for which we have historical information which we can use to measure their impact – and uncertainties, for which there is no known historical precedent so we have no way of knowing how they will impact us. If an airline hedges against the price of fuel, that is a risk. What is happening in the Middle East right now is an uncertainty.”

CFOs and CEOs can’t do much about uncertainties, but they can help their companies manage risk more effectively. “Every entity exists to create value for its stakeholders,” says Dufey.

“Value is created, preserved or eroded by management decisions in every aspect of a company’s activity: from setting strategy to operating the enterprise. And all important decisions are fraught with risk.”

Without risk, there is no profit. So the goal isn’t to minimize the risks a company takes, but to choose the level of risk that will best maximize shareholder value.

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