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Executives spend less than one-third of their risk-management efforts on emerging risks – outlier threats that are unfamiliar.
Sarah Johnson, CFO.com | US
April 18, 2012
Kevin Gordon, finance chief of Quintiles, which provides services to pharmaceutical and medical-device companies, has risk management on the brain. For CFOs, risk management "is on our minds from a financial perspective every minute of the day," he says.
Many CFOs like Gordon have seen their responsibility for managing companywide risks steadily increase in recent years, particularly after the financial crisis highlighted the need for a thorough understanding of risk exposures and the value of having processes and plans in place to identify and manage them.
But one of the most challenging parts of that responsibility is understanding emerging risks — those outlier threats that are either unknown or on the periphery of a CFO's day-to-day view. "An emerging risk is either something we've never seen before or something we haven't seen for a long time," says Max Rudolph, owner of eponymous firm Rudolph Financial Consulting. Thus, he says, examples can be given only in retrospect: think last year's Japanese earthquake and tsunami, political uprisings in the Middle East, and the European debt crisis — all of which had a ripple effect on U.S. companies' supply chains, commodity costs, and liquidity.
As with most things that are complex and unfamiliar, executives tend to focus on the issues they already understand, rather than expend the time and energy to delve into an unknown threat that may not occur or have a material effect on the business.
For now, executives devote 28% of their risk-management efforts, on average, to emerging risks, according to a forthcoming report by consulting firm Oliver Wyman Group. The rest of the time they are focused on the more front-and-center risks. The same report states that 78% of the more than 200 executives surveyed want to increase their capabilities when it comes to managing emerging risks. "The interconnected nature of the global economy is increasing both the speed at which emerging risks arise and cascade, as well as the magnitude of their impact," says Alex Wittenberg, a partner at Oliver Wyman and head of its Global Risk Center.
Word of Mouth
To be sure, one company's emerging risks may not be another's. They depend on a company's size, strategy, and financial strength. But CFOs find one of the most effective ways to become aware of emerging risks is to talk with colleagues at other companies (through either peer exchanges, board memberships, or networking events) or read about the issues facing other businesses. Senior finance executives in health care, for example, attend such events to hear how their colleagues are preparing for the Patient Protection and Affordable Care Act's regulations and their implications.
Some third-party subject-matter experts and service providers publish periodic reports ranking emerging risks from highest to lowest level of concern. Companies can compare the list to their own internal lists and risk tolerance. "A lot of [risk management] is being aware of what's going around in the world around you," says Mark Verbeck, CFO of Coupa Software.
A report released today of those who live and breathe risks — actuaries — is one example. Nearly half of more than 200 actuaries surveyed by the Society of Actuaries, the Casualty Actuarial Society, and the Canadian Institute of Actuaries rated financial volatility as the single greatest emerging risk, followed by failing governments, cybersecurity, an asset price blow-up, and an economic hard landing in China.
For CFOs, regulatory risks invariably rank high on their list. They often experience uncertainty over how proposed rules will shake out and the danger that rule enforcers will be overly aggressive. In particular, when it comes to potential tax-code changes or interpretations, finance executives cannot look away, when such a change could affect their earnings or, at the least, distract the finance department from its core responsibilities.
New to Coupa as of January, CFO Verbeck is still smarting from his company's last California state-tax audit. Since he joined the spend-management software company, Verbeck has put new processes in place, based on what he learned at his former employer, so that Coupa will be better prepared when the taxman comes knocking again. "We need to make sure our internal resources can address that risk," he says.
Similarly, Gordon keeps close tabs on regulators' activities in the 60 countries in which his company does business. And he also pays attention to other international economic developments. For instance, when the European debt crisis took shape last year, Gordon's inner risk manager kicked in. Quintiles went through a month-long process of analyzing its cash holdings in overseas financial institutions and examining those banks' stability. It moved some of its cash around after analyzing how best to mitigate the risk of changing currency rates and any tax hit from bringing cash into the United States. The exercise made Gordon aware of a new risk: changing overseas banks can take longer than expected.
To stay one step ahead of what's coming, CFOs need to examine more than just the potential impact of emerging risks. "It's not enough to attempt to qualitatively identify and assess emerging risks," Wittenberg says. "Organizations need to recognize the factors that combine to create emerging risks as well and to understand and develop their ability to quickly respond."