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Risk appetite is returning but has it matured?

Risk is inevitable, but CFOs and boards are more aware nowadays and ready to face it head on

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In the halcyon days of the early to mid-2000s, there was hunger for bold decisions by top companies, whether it was gobbling up other businesses, expanding or transforming their businesses.

During the more austere days of the post-financial crisis, the appetite for risk diminished. Instead of looking to acquire and grow the business, boards focused on building up their cash reserves ensuring liquidity and a buffer for future uncertain times.

Business, by its nature, cannot be shorn of risk and neither would business leaders, least of all CFOs – despite their inherent caution – want risk-free business, where’s the fun in that?

"Most experienced CFOs recognise you have to take risk to get returns," says Eddie Best, business risk partner at Grant Thornton.

Risk appetite may have lessened but of course it’ll never disappear because although some industry sectors have suffered during their prolonged economic crisis, others have blossomed.

This hunger is most apparent in the commodities market, with the mooted merger of Glencore and Xstrata the highest profile of a series of mergers and acquisitions taking place. In the oil and gas industry, Shell's potential £1 billion acquisition of Mozambique-based Cove Energy demonstrates an awakening of this hunger. The big question on CFO's lips is when, not if, the resurgence in activity will come.

Following the feast of much of the previous decade, and the subsequent indigestion during the financial crisis, boards’ risk appetite has finally returned. But this appetite has changed. Now, few corporates would dare take major decisions without an intense focus on risk management. In past, arguably risk management was less of a priority than it is today.

Ed Ainsworth, co-found of 4C consultants, says this is not necessarily because companies were less responsible pre-crisis. Instead, the crisis has highlighted risks that would not have been thought of six years ago. For example, then chancellor Gordon Brown declared the end of boom and bust in 1997, and many companies simply didn't see an end to the cheap and abundant credit on offer.

"If you'd asked companies a few years ago, they would have said they were risk averse," Ainsworth recently told delegates at the Economist CFO Summit. "People hadn't realised how much risk they had been running, whether it was the changing economy or potential issues with their supplier."

The financial crisis has brought with it a greater understanding of potential risks. Ian McHoul, chief financial officer of FTSE 100 engineer Amec, says this new understanding has changed CFOs' risk priorities.

"We all sit around and do risk registers around a business," he tells CFO delegates. "Typically there is a box called 'catastrophic consequences that have a very low likelihood'. Historically, there hasn't been much focus on this box. Now there is."

Apart from the usual risks associated with business such as a supplier going bankrupt or a product failure, catastrophic natural or man-made disasters are increasingly on boards’ radars. And in the past year the world hasn’t been short of these – the Japan tsunami and earthquake, the Thai floods, and the Arab Spring uprising whose repercussions continue to be felt, are just a few that have shook the world recently.

The human impact of these events aside, the knock-on effect on businesses are multifaceted. Consequences such as an increase in the cost of oil, the effect on the supply chain and even the shrinking of the market could destroy a business.

Issues such as escalating fuel costs and broken supply chains are not exclusive to these catastrophes, of course. Ainsworth points out that the financial crisis has bankrupted many suppliers.

Other new risks are emerging all the time. Perhaps the most dangerous new risk, says Ainsworth, is reputational risks caused by supplier behaviour. The damage to BP's reputation from the Gulf of Mexico oil spill was arguably as great as the cost of the clean-up for the company, he says.

But these new risks cannot be eradicated because they are part of the new world order – globalisation and more disparate operations. What has changed is a heightened awareness of the different and emerging risks and their potentially devastating consequences. Boards are simply paying more heed to mitigation – the other option is to stand still, which is not really an alternative.

So how are they doing this? A review of governance structures is one way of mitigating risks. Todd Gibbons, vice-chairman and chief financial officer of BNY Mellon, an asset management business, told delegates: "You can tell how seriously a company takes risk by whether it is embedded into the governance structure."

His company has a risk committee in place which looks at an employee's ability to manage risk in performance reviews and has a risk appetite index approved annually by a board of directors.

But while strong governance is essential, Gerard Gallagher, advisory lead partner for markets at E&Y, suggests excessive governance and controls does not always help in risk mitigation. "Many of the FTSE 100 are looking at rationalising enterprise wide controls because it can inhibit agility and innovation, both of which in our experience are vital to succeeding in uncertain times," he says.

Grant Thornton’s Best points out that many companies cut back on governance controls as cost-cutting measures, believing risk and internal compliance to be discretionary spending, even though they are now reinstating them.

But if governance and controls are not the panacea to effective risk management, embedding risk into the company strategy is something that finance chiefs can agree on. Indeed, finance chiefs appear to be applying similar strategies and risk management processes.

The most common way of aligning the two is through scenario planning. Luca Zamaralla, CFO of Kraft Europe, says this is central to an effective strategy. "What is critical to us is scenario planning and an understanding of all the variables. We need to come across the strategy that is most cost effective and allows us to mitigate potential risk. The covert strategy never stands alone," he says.

Wolfgang Kniese, CFO of T-Mobile Austria, agrees: "I tend to think about risk management as the flip side to strategy. When you think about strategy, you usually look at what assets, what people, what knowledge I have. It is the same as the downsides for risk – what am I missing, what can go wrong?"

There will never be a lack of risk appetite for corporates that are set on achieving growth, because any strategy inevitably entails risk. But that is not to say that the risks involved cannot be mitigated. A lesson that corporates are, if not learning now, then at least applying more in practice.


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