How can businesses protect themselves in a world where risks have become increasingly entwined?
Rapid globalisation over the last 20 years, combined with changing business models and huge technological advances especially around the internet, has resulted in increasingly interconnected systems and processes in society.
This has delivered many benefits to us all but also resulted in growing interdependence, which has led to new, interconnected risks. These risks typically spread rapidly across countries and sectors and are best evidenced by the global financial crisis. However, senior decision-makers and risk managers can prepare their businesses for such large-scale shock events by better appreciating the nature of these new risks.
Business continuity planning, board-level consideration of risk when setting strategy and the stress testing of supply chains can all help business manage these complex, and potentially business threatening risks.
Interconnectivity of risk is a relatively new concept that can mean different things to different businesses. However, recent events have shown how seemingly unrelated events can have a devastating impact on business globally.
Few would have foreseen that the eruption of an Icelandic volcano last April - which grounded almost all UK commercial flights for a week - would disrupt the availability of fresh produce from Kenya in UK supermarkets, or car parts exported to Japan from Europe.
Societies and economies have become more integrated and this has created a new type of risk, notably systemic risk, according to a recent Lloyd’s 360 report Globalisation and Risks for Business. Neil Smith of Lloyd’s Exposure Management says: ‘Globalisation has added new dimensions to risk, enabling risks to spread more quickly, jumping traditional risk boundaries, and travel further across countries and sectors.’
Globalisation has not necessarily created new risks, but together with changes in the business environment, many companies are now more exposed to the impact of unforeseen events.
The increase in interconnectivity is a product of globalisation, but it is also driven by changing business models, says Paul Hopkin, technical director at the Association of Insurance and Risk Managers (Airmic) in London.
Historically companies have controlled large parts of their manufacturing process - a low risk strategy that comes at a relatively high financial cost.
However, modern business practice is typically focused on driving out cost and this has resulted in far less control over the sourcing of materials, manufacturing and distribution of goods and services. This strategy comes with increased risk, which only becomes apparent when a large disruption like the financial crisis occurs.
‘Risk has become the forgotten element in company strategy. Companies need to adopt a more analytical approach in terms of challenging the assumptions and dependencies that underpin their business models,’ says Hopkin.
‘There needs to be a cultural change at board level to address the interdependency of risks. Rather than focus purely on cost, senior management needs to ask questions about the quality and the robustness of the supply chain.’
The financial crisis, last year’s influenza pandemic and the volcanic ash cloud have raised awareness of the interconnectivity of risk among leading companies. ‘Clients haven become increasingly more aware of their supply chains, which is at the core of risk interconnectivity,’ says Jonathan Bogan, director at Lockton.
Globalisation is a challenge for companies and the risk management profession; however, companies are beginning to address the interconnected nature of risks.
Business needs to develop its risk management systems to identify and understand the drivers of interconnected risks.
They should conduct systemic risk audits, develop contingency and disaster management plans, as well as test scenarios,’ Bogan says.
Enterprise-wide risk management (ERM) frameworks are a good way of addressing interconnected risks. They provide the tools required to model risks, such as those affecting a supply chain, and help embed risk management in the organisation and engage the board and senior management. As a result, enterprise-wide risk management and business continuity management have been pushed higher up the agenda.
Changes to the UK Corporate Governance Code also continue to place more emphasis on risk management and resilience in listed organisations, whilst globalisation has helped spread the discipline of risk management around the globe. Increasingly, risk management is being practiced in India, China and South East Asia. Demand for risk managers in these regions has been growing, and we see a transfer of risk management and mitigation expertise as these countries looking to the US and Europe for training and guidance.
For further information on Risk Management issues please contact Jonathan Bogan at Lockton jonathan.bogan@uk.lockton.comtelephone 011 7906 5000.
Lockton manage the ACCA members Professional Indemnity Scheme. Parts of this article have been taken from Lloyd’s 360 Latest News Bulletin.