As the dust from 2015 settles, Canadian business leaders return to their desks facing a daunting list of new and emerging risks in 2016. The big winners will be those executives and boards who work collaboratively to select the best growth opportunities, and take calculated risks pursuing them. How will they do this?
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Oil and commodity prices dropped sharply last year leading to a big drop in the Canadian dollar. On the rise are cyber risks, weather threats, terrorism, emerging and disruptive technologies, and possibly Canadian interest rates. Very concerning is no correction in-site for the economy and stock market in China, this negatively impacting resource economies and stock markets like those in Canada. Add to this mix explosive tensions in the middle east, and one can see a volatile year ahead for decision makers. However, never before have Canadian executives and board members been better equipped with formal risk management tools to address on such risks.
The need to succeed in volatile times is not a new expectation of those top business leaders who wish to thrive in today’s continually changing world. The financial crisis of 2008-2009 culled out many of those executives and directors who were not able to survive the turbulence, and much blame from that era shifted to those boards which failed to react quickly to evolving risk scenarios. Since then, much has been done by regulators, stock exchanges, shareholder activists and industry to attach accountability to directors for the risks of their organizations, and this trend will become a key story in board governance in 2016.
“The average return … was 57 percent higher… (when board committee charters) …documented the need for a risk expert”
Perhaps most high profile activity has occurred within the Canadian, US and UK financial systems, to create both accountability and results through requiring increased board risk oversight. In 2015, the US Federal Reserve EPS (Enhanced Prudential Standards) mandated banks of a certain size to significantly increase risk governance, including mandating an independent risk expert to be on board. In September 2014, the UK’s Financial Reporting Council stipulated that “The board is responsible for determining the nature and extent of the principal risks it is willing to take in achieving its strategic objectives. The board should maintain sound risk management and internal controls systems.”1 The Canadian Financial Institutions regulators (OSFI) have also recently increased risk related requirements. But is the call for better risk oversight being heard and is it working, or this this yet another time- consuming compliance exercise? Indications are that boards in many industries are moving to create a formal risk oversight function (either a separate board risk committee, or a sub-committee under say Audit or Governance), and, that this increased focus on risk is having a financial impact. In its 2015 study of US banks with and without strong risk governance practices, Deloitte concluded that those groups with better risk practices had dramatically better results.2 Two groups of US banks were analyzed and each showed substantially different operating results. Per the Deloitte report: “The average return on average assets (ROAA) in one group was 57 percent higher. Otherwise—in terms of average total assets and other characteristics—the two groups were roughly similar. One key difference between the two groups was that the board risk committee charters of the higher-performing banks documented the need for a risk expert.”
“Study results: Better risk management preserves equity value especially in periods of stress”
Further, a 2014 study by McKinsey showed that Insurance Companies with stronger ERM capabilities outperformed competitors in terms of reduced volatility and stock price. As noted in the report, “Investors place a premium on lower volatility stocks for any given level of return. Better risk management preserves equity value especially in periods of stress.” 3
While the Deloitte and McKinsey studies may not be proof of results, more telling is the general trend amongst international board communities toward making oversight of enterprise risk a top priority.
What’s Happening in Canada
In Canada, the efforts by governing bodies such as the Toronto Stock Exchange (TMX), Chartered Professional Accountants (CPA), and Office of Superintendent of Financial Institutions (OSFI) to embed risk oversight guidelines within their member boards, highlight that value is created by taking calculated risks following an ERM system. Both the Institute of Corporate Directors program (ICD.D), and the Directors College program (C.DIR) now teach ERM as part of their respective curricula, and as recent graduate directors take board seats, risk is becoming a top agenda item. This subject was the cover story in the Fall 2015 issue of Listed Magazine (the magazine for Canadian Listed Companies), per the article entitled “Oversight Means Line of Sight”. As noted, “while Executive pay still commands the most public attention…for the majority of directors and executives, risk is now its equal among top priorities…identifying, tracking, and mitigating risk will likely be the major focus for boards over the next decade and beyond”.4
2016 and Beyond
So what does this mean for interaction between management and the board on risk, and how can both work collaboratively to face a potentially risky 2016? As boards increasingly restructure with risk committees and/or new risk reporting lines, bring on risk experts, and adopt new best risk practices, expect much more dialogue, interaction, information requests, transparency, and reporting. Says Robert McFarlane, member of the Audit and Risk Committees of the Boards of HSBC, InnVest REIT, and RSA Insurance, “it is very healthy for a board to receive an unfiltered assessment of what different levels of the organization perceives as higher risk”. 4 Nancy Hopkins, Chair of Cameco’s Nominating, Governance and Risk Committee, comments that increased interaction between board and management on risk also means involvement by more and more people throughout the organization, as risk practices spread entity-wide. “We want to make sure that risk is embedded in the organization in a more substantive way…it needs to be integrated with strategy and it needs to be thought about through-out the organization”. 4
Conclusion
Aligning risk with strategy doesn’t mean retreating from opportunities, rather it means being more calculated in choosing the right strategic direction. In 2016, expect a continued focus on best risk practices by good executives and by experienced board members, resulting in more involvement, interaction and dialogue within all levels of the organization, and in between board and management. Is this increased management and board dialogue to be confined to public companies and banks? No. Most industry leading firms, public and private, now boast robust risk practices. As ERM becomes adopted by progressive executives and recently educated business leaders, formalized risk management is a necessary tool to help steer through choppy waters.
References
- Financial Reporting Council. 2014. The UK Corporate Governance Code. London, England. www.frc.org.uk
- Deloitte Development LLC. 2015. Bank Board Risk Governance. USA. www.deloitte.com
- McKinsey Financial Services Practice. 2014. From Compliance to Value Creation: The Journey to Effective Enterprise Risk Management for Insurers. USA. www.mckinsey.com
- Listed Magazine. 2015. Oversight Means Line of Sight. Toronto, Canada. http://listedmag.com/2015/10/oversight-means-line-of-sight/
