Finance: Don't be negative about risk

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The Independent Online
WHEN THE managements of companies think of risk, they tend to focus on the negative. And there is little doubt they are encouraged in this by accountants inclined to see the downside of many a situation.

The recent survey from accountants at Deloitte & Touche showed nearly a quarter of Europe's top infrastructure companies fail to make non- financial checks before investing in emerging markets. This is likely to have put many waverers off the idea of expanding into such territories.

And the release from prison of Nick Leeson, the man who broke Barings Bank, provides a reminder of the risks of trading in areas in which senior management has little understanding. It is not surprising so many executives and organisations are risk-averse.

Such a preoccupation with the downside is acknowledged in a study by the Institute of Chartered Accountants (ICA) of risk-reporting in publicly- quoted companies. Earlier this year the accounting Standards Committee of the Scottish Institute of Chartered Accountants said it believed most readers of accounts will focus on the negative connotations of the word "risk".

Some organisations try to avoid such problems by differentiating between risk, meaning the negative side of uncertainty, and opportunity, meaning the positive.

The ICA group responsible for the study says: "Companies are taking an integrated approach to identifying, prioritising and managing the individual risks in their business to manage their overall risk. It is unhelpful to undermine this integrated approach by using different terminology to distinguish between sources of upside risk, sources of downside risk and sources of uncertainty which include a mixture of both."

There is growing evidence organisations see risk-management as a key element in achieving what has become a holy grail for executives - shareholder value. Many organisations equate the in-vogue management term with short- term profitability, since that is generally a sure-fire method of boosting a company's share price, and hence its value to shareholders.

But the focus is shifting from one-off increases towards sustainable growth. Executives are abandoning their fixation with the negative aspects of risk and seeing the connection between well-managed risk and improved performance. John Bromfield, head of the risk management practice at accountants PricewaterhouseCoopers, says: "Risk management is vital to the long-term growth of any organisation."

He agrees the discipline uses "a bewildering array of complex terminology" and his firm has produced a guide providing "a clear overview" of risk- management and the various approaches. Mr Bromfield says it is "designed primarily to give management the know-how for turning risk into reward".

The financial benefits of a clearer understanding are apparent to Robert Hodgkinson, a partner at the accountancy firm Arthur Andersen and chairman of the ICA group which set up the study. He says: "Disclosure of risk and how they are managing it is a weapon directors need to secure the lowest cost of capital and deliver shareholder value." For all the debate on such matters as directors' willingness to report on the effectiveness of internal controls, and the Turnbull report on the implementation of the Stock Exchange's combined code on corporate governance, Mr Hodgkinson and his colleagues believe the question for directors is not: "Do you want to report on risk?" They say the issue is: "Do you want to do a better job of reporting on risk?" They suggest an overall goal of "no surprises".

There are widespread misgivings about directors' liability and commercial sensitivity, but the group says such objections cannot be sustained. "New thinking is called for," it says in the report No Surprises - The Case for Better Risk Reporting. "Companies need to see disclosure to investors as a way of securing competitive advantage in capital markets and use technology to make disclosure more efficient and effective."

Or, as the PricewaterhouseCoopers paper, prepared with the International Federation of Accountants, puts it, companies need to get away from the old concentration on conformance and focus more on performance. This means not seeing risk management as trying to protect from losses. It entails focusing on "actively managing risks that must be taken in the pursuit of opportunity and, ultimately, profit".

To do that requires detailed analysis of the risks, to capitalise on opportunities, such as those manufacturers who picked up cheap facilities in the wake of the Far East economic troubles. What a company does not want is to succumb to what are commonly known as risks, as companies which fail to check out business partners and acquisition targets in emerging markets are apt to do.