While companies in the Irish pharmachem sector obviously face differing business risks to those in financial services or agribusiness, business risk is a fact of life for every organisation – large and small.
One commonality of the risks facing all businesses is the fact that the effective management of risk is vital. Another is that the risks are growing more complex and global in their nature. It is therefore no surprise that one of the major themes of this year’s World Economic Forum (WEF) in Davos, Switzerland, was the issue of global risks, their impact on our society and the need for a co-ordinated response from both business and government.
Core Risks Identified
To facilitate the discussion and framing of a co-ordinated response to these global risks, Marsh and its parent organisation Marsh & McLennan Companies (MMC) joined forces with the World Economic Forum (WEF), Citigroup, Swiss Re and the Wharton School Risk Center to identify the core global risks faced by local and global businesses. The resulting report, Global Risks 2007 (available on www.marsh.ie/research) identifies the five “Core” Global Risks. And while these risks have a global complexion they also have a direct impact on local businesses.
These “Core” risks are described as follows:
- Economic – oil price shocks, Chinese economic hard landing
- Environmental – climate change, loss of freshwater sources
- Geopolitical – retrenchment from globalisation, international terrorism
- Societal – pandemics, liability regimes
- Technological – risks associated with nanotechnology, critical information infrastructure failures.
How to respond to global risks in a local market
Any examination of the catastrophic natural and man-made disasters of recent years – from Hurricane Katrina to the Buncefield oil terminal explosion, demonstrates that our ability to confront risks depends more on the systems we put in place before a disruption than the actions we take immediately following such an event. It is vital, therefore, that both businesses and government incorporate appropriate reaction to risk events as well as proactive enterprise risk management and advance planning. A combined proactive and reactive approach will help to reduce the likelihood of risks occurring and minimise the impact of events which do occur.
In approaching the root causes of the global risks, the report recommends a number of key requirements for addressing specific global risks, including:
- Linking energy security with considerations on climate change;
- Urgently beginning work on a successor to the Kyoto agreement with three central principles:
- Involvement of the United States and major developing countries (particularly China and India);
- Differential responsibilities for future emissions’ reduction dependent upon past emissions and stage of economic development; and,
- Common overall responsibility for climate change.
- Renewing terrorism insurance schemes scheduled to end in 2007;
- Improving frameworks for public-private arrangements;
- Increasing research into the identification of critical choke-points in the supply/value chain where skill sets are rare, interdependencies are greatest and the risk of triggering systemic failure is highest – particularly with regard to pandemic preparation.
At a more localised level, the first step in approaching risk mitigation is generating awareness of the existence of the various risks facing a business and their interdependencies.
One way to do this is to use correlation to provide an overview of the links involved in the various risks faced. Taking a simple example, a correlation matrix of the global risks identified in the Global Risks 2007 report shows clearly that oil price shocks have a strong correlation with asset prices and indebtedness. This in turn affects the current account deficit in the US which is highly correlated to an economic hard landing in China – an economy that many Irish and international companies are actively targeting for business. The recent volatility in equity markets which saw several billion Euro wiped of the value of the ISEQ and which was sparked by instability in some Asian markets shows clearly the local impact that these global risks can have. Thus the risks that may appear global on the surface can have a direct impact on local businesses beyond the obvious, requiring a well planned and proactive risk management response.
Another part of the process is to calculate the financial impact of the risks. Finance teams obviously play an important role in this process. Aside from actuarial principles, discount rates can also be applied to calculate the net present value of future costs which could arise from not acting to mitigate the risks.
Taking the example of an economic hard landing in China, the Global Risks 2007 report assessed the likelihood of this occurring as being in the 10% to 20% range. The global financial severity of this happening is assessed at between US$250bn to US$1 trillion. Bringing this into an Irish perspective, it is clear that any company which is investing heavily in marketing products to the Chinese market should factor in the likelihood of an economic hard landing (10% to 20%) and the impact of that on their business plans. A further complication for a company in this scenario is that the underlying cause of an economic hard landing in China could be reduced consumption in Western markets following from economic pressure as a result of a major oil-price shock. Thus not only are the Irish company’s exports to China affected but so are exports to other markets at the same time as energy costs are rising.
Thus by increasing the level of understanding of the relationship between global risk events and their local business impact an appropriate risk management strategy can be designed and implemented. In addition, by raising the general level of risk awareness, it is hoped that business and government can work more closely to deal with the root causes of risk rather than simply reacting to the consequences of an individual risk event.
In the face of far reaching global risks it is natural for individuals to feel overwhelmed. While just one person can make a difference, the magnitude of risks facing us in the years ahead requires more than an individual effort. Real mitigation of global risks requires a coordinated response and strong leadership from both businesses and government. Inaction from either party simply isn’t an option.
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© The Institute of Chartered Accountants in Ireland, 2007.