Risk & Economy » Why finance leaders must have an appetite for risk

The world has become a risky place. For years commentators were warning about a wave of disruptive forces, driven by technology, unleashing catastrophic damage on the business models of established, profitable companies. That scenario is now playing out everywhere.

In addition, the potential for greater risk has been created by geopolitical challenges that are starting to undermine the ability of companies to plan for the future- reflected in the IMF’s forecast last month of a slowing global economy.

David Leithead, chief operations officer of the UK arm of executive search firm Morgan McKinley, says it is becoming increasingly important for CFOs to be able to develop a better understanding of risk- given the fast changing and disruptive environment.

“Modern risks around data privacy, technology, and information security, are potentially catastrophic, so CEOs and business heads want to act on them but it can be hard for CTOs and CMOs to pin down, explain and quantify the risks, let alone the solutions available. The CFO plays a key role in bridging the knowledge and communication gap and thus galvanising the organisation’s overall risk management strategy,” says Leithead.

The ability to understand where their organisation should sit on the risk-opportunity spectrum, or developing an effective risk appetite, has become key to CFOs and other leaders, says Leithead.

Most business leaders agree the need to mitigate risk but how many of them want, in this economic climate, to throw the kitchen sink at it? Leithead ask. “If we set out to be best in class, to set the industry standard, we may end up spending a huge amount of money, only to self inflict a business limiting commercial straitjacket. The CFO has to officiate the tug of war between the commercial heads and the risk management heads, and get help their organisation strike the right balance,” he says.

Appetite for risk

Elaine Collins, a professor at the UNSW Business School, in Sydney, says risk appetite depends entirely on the environment a corporate is operating and its strategic objectives, and the pathways taken to take to reach their objectives. “There’s a big choice of pathways that will determine what choices they make, especially when the environment is complex and challenging. So in that context it may take some deep thinking about what route, which strategy to take,” she says.

Prof Collins, who has sat on a number of Boards including that of the Australian arm of Zurich Insurance, says some key questions need to be considered by corporate leaders. “How difficult is it to align risk appetite with those issues? Is it aligned with the company’s vision? Is it aligned with the objectives of the shareholders?

“They have to think about what do the risks look like and how likely they are, what their severity might be. What is the enthusiasm  for a risk profile? In a more complex environment you might have lower tolerance, so it is incumbent on companies to look at this regularly, perhaps annually. But they should look at in a different way when the environment changes”, she advises.

Ensuring the communication around risk is effective is absolutely critical, says Prof Collins, referring to a recent royal commission into misconduct in the Australian financial services industry, which she says “demonstrated how financial institutions did not express clearly their risk appetites, and did not deliver on expectations.”

Prof Collins says a Board-led approach, featuring a powerful statement on risk “should be forward looking, part of an overall strategy, should have tight wording, and should cascade down to the frontline staff of the organisation. It creates a of risk culture because cascading down means everyone knows what the risk appetite is and what it means to the organisation, everyone is aligned in their thinking and execution of their roles.”

Risk culture

Corporates have to regularly refresh their risk cultures. “You can have all the best technologies in the world, but if you have a poor risk culture you’re not going to be well protected. The tone needs to come from the top, executives need to demonstrate in Board meetings, committee meetings, consistency across the whole organisation, the kind of culture, approach you want everyone to have,” she says.

When it comes to the traits of a strong risk leader, Prof Collins says: “It is really important that they get the business to understand how risks are managed, not as an examiner giving a bad mark if it doesn’t manage risk well, but through monitoring. Risk leaders should see themselves as being at the front line, with the second line being all divisions of the business collaborating with the first line to manage their risks better,” she adds.

Morgan McKinley’s Leithead says external advisors can play a key role in helping finance leaders to develop their risk awareness. But he says it’s essential, when the application of regulations are often evolving fast, to have a challenging and inquisitive mindset. “An important tactic is to go beyond those paid advisors, to look outside the organisation to gain industry perspectives, from conferences and white papers but also from direct conversation with peers and competitors,” he adds.

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