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The buck stops at the top

Political turmoil, the financial crisis and climate change are forcing board directors to play a more active role in managing risk

20 May 2012

The board of energy giant Royal Dutch Shell regularly sits down and plays out disaster scenarios. Advised by the company’s business intelligence unit, the board imagines what would happen if there were an atomic conflict between China and India, or if the euro collapsed, or if things became (even more) chaotic in Russia.

More importantly, it works out what the company should do about it. “As the world becomes more crowded, the stresses between the essentials of life – water, food and energy – will become more critical. Climate change is likely to intensify the stresses. These are huge, integrated challenges and there is no time to waste if the world is to tackle them effectively. We need a new level of collaboration and leadership to develop workable policies and solutions. We need vision and action,” warned Shell CEO Peter Voser, in a recent speech.

At high-tech giant Siemens, the board has taken even greater measures to deal with financial risk. The company has started its own bank, and now runs a fully-fledged financial services division that makes project management loans, hedges against foreign exchange risk, and trades on the financial markets. Last year the bank withdrew €500m (£400m) from other banks, and parked them with the European Central Bank as a safety measure during market volatility. “In the case of another financial crisis, we will be able to broaden our flexibility and take out risk with our own bank,” said Roland Châlons-Browne, chief executive of Siemens’s financial services unit, at the time.

Few companies have the size and resources of Shell and Siemens, but, across all sizes and types of corporates in Europe and the US, boards are taking a more active role in managing financial, operational and external risks at their companies. “Since the financial crisis, boards have felt the need to step in on risk, and they have been obliged to take action,” comments James Lam, director of the Boston-based risk management firm James Lam & Associates.

According to insurer Allianz Group’s survey of risk managers worldwide, economic risk is the most dangerous risk today but is closely followed by fears for business interruption.

Says chief economist at Allianz Michael Heise: “Nervousness and volatility in the financial markets have the effect of destroying business confidence, then slow activity in the real economy.  This in turn further unsettles investors and the markets. Assessing all of these risks becomes not just a matter of protecting a business, but of enabling it to compete.”

Rentokil has won awards for its risk management policies. The business offers services in cleaning, pest control, laundry, parcel delivery, and hygiene in Europe, Africa, Asia, and Asia Pacific. “The board at Rentokil takes an active role in managing business continuity risk – that is, making sure nothing threatens their safety or keeps them from running our businesses,” explains group risk manager Iain Hovell.

To help the board tackle risk, the firm developed a risk management tool for business continuity that applied the same standards across all its divisions. The tool has been adopted at each local company, whether it has 15 employees or 3,000.

Perhaps unsurprisingly, boards in financial services companies are having to deal with a sharp change in the risk climate since the financial crisis. This is characterised by a barrage of regulation. Concern about not being in step with Dodd-Frank, UK Company Law of 2006, Basel III, Solvency II, European directives on finance and corporate governance, as well as local country legislation, place a heavy burden on boards. And boards at financial services companies tend to face an additional risk: if they do not do a good job with risk management, they often find themselves out of work.

As a result there are two risk management trends at work among financial services firms. Firstly, the board members themselves are being selected less from the deal making, and more from the administrative and support sections of the firms. Then, banks and insurers are adopting and developing increasingly sophisticated forms of enterprise risk management systems, ones with more comprehensive internal controls. Some experts say the kinds of financial products that led to the financial crisis would not be possible with the current risk controls in place. Others disagree, insisting that financial innovators will always outpace our ability to control them. The debate continues, among regulators, bankers, and others in the industry.

Clearly risk is a challenge for boards, but it is also an opportunity. “By controlling risk, a business gets closer to its creative processes.

“Competitive advantages emerge from risk management,”says Lam.”

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