Most companies have experienced (or will experience) significant financial damage in their lifetime due to an unforeseen risk event. Companies that fail to proactively identify and prepare for these risks can easily be caught off guard, often exacerbating the financial impact and lengthening the time required to address and mitigate the risk. As part of the quarterly surveys CEB conducts with risk officers at Fortune 500 companies and other organizations around the globe, we have identified the top five emerging risks companies are seeing today. Based on these findings, we are able to capture the impact a risk event has on traditional risk categories regularly tracked by companies, how these risks have changed over time and which risks will likely have greater impact in months to come.
Traditionally, emerging risks specific to the financial crisis and the regulatory environment have been at the top of most risk officers’ lists in terms of both impact and likelihood. However, the most recent survey from CEB revealed an interesting change. While regulatory and macroeconomic risks remain a significant concern, a new risk has emerged as the top concern for risk management heads: cybersecurity.
Costly information breaches are not only top of mind for information security professionals and members of the media, they are also gaining the attention of senior executive teams. Companies’ increasing reliance on data collection and analysis heightens the risk of loss or misuse. In addition, external threats continue to evolve and grow more sophisticated. Specifically, state-sponsored hacking by countries such as China and Syria create a serious and well-funded threat for many large companies. Cyber attacks often lead to moderate to severe disruption of company operations, and in some cases, can damage a company’s reputation and business prospects. According to the Center for Strategic and International Studies, the annual economic toll for the U.S. economy could be as much as $140 billion.
2. Continued Recessionary Pressure
Continued recessionary pressure remains a key concern for most risk officers, particularly as it relates to macroeconomic, political and financial risks. While the U.S. economy appears to be on stronger footing, CEB’s index of global business confidence, which incorporates senior executives’ sentiment on revenue growth and cost pressures in the next 12 months, remained flat in the second quarter. This is in large part due to government fiscal austerity, ongoing weakness in Europe and slowing growth in Asia, all of which have weighed negatively on growth expectations.
In addition, the expected tapering of U.S. credit-easing measures could have a substantial impact on the global economy. Many experts suggest that sharp declines in the currencies of emerging economies are possible along with an appreciation of safe-haven currencies such as the U.S. dollar and the Japanese yen. Interest rates will certainly rise and equity markets, which many claim have been artificially supported by quantitative easing, are likely to experience downward pressure in the near term.
3. Corporate Fraud
Executive teams are now managing their businesses in work environments shaped by frequent reorganization, increased knowledge work, more interdependent work, increasingly distributed global teams, and less managerial oversight. This evolution of the modern-day work environment has left companies at an increasing risk for employee-related misconduct and significant repercussions that extend beyond just financial penalties. In particular, fraud has become a significant issue for many companies in the current economic environment, as the financial implications remain significant. In fact, approximately one in 20 employees reported observing fraud by an employee within the past year. However, CEB research also suggests that organizations can decrease their exposure to fraud by as much as 50 percent if they successfully create awareness about fraud and fraud-related policies.
4. Corporate Tax Reform
With staggering amounts of cash on corporate balance sheets, many expect corporate tax reform to soon take center stage, a change which in turn could lead to lower corporate profitability and growth. Despite concerns that a tax reform deal might happen sooner than expected, following U.S. Senator Max Baucus’ announcement to not seek re-election next year, CEB’s findings show only a slight increase in the likelihood and impact ratings for this risk. This links back to the strengthening U.S. economy and smaller-than-expected deficits, which have significantly dampened the urgency for a deal this year.
5. Emerging Market Slowdown
Not surprisingly, many companies remain concerned about the economic slowdown in emerging markets – most evident in India, Brazil and China – as growth opportunities shift to the U.S. and Europe.
The Chinese economy is an area of particular concern, given the dramatic impact the country’s attempts to rebalance its economy along a slower growth path is having on the rest of the emerging market economies, as well as the entire global economy. Also, many companies are actively monitoring China’s demand for commodities, as any decrease may have a far more pronounced effect on the global economy because it will put pressure on commodity prices for a potentially extended period of time.
While risks related to the financial crisis have been center stage for some time, many CEB clients are expecting to continue their heightened focus on emerging risks such as cybersecurity, shareholder activism and qualified talent shortage in 2014. Regulatory issues also remain a concern in the U.S.; a small fiscal agreement is expected as a result of the deal to reopen the U.S. government and raise the debt limit, while market reaction to an eventual Fed tapering remains a considerable concern for many companies and a risk they are monitoring closely. However, the upcoming U.S. mid-term elections and turmoil concerning the Affordable Care Act implementation will likely shift the focus off of legislating and back to politics.
Best Practices for Managing Emerging Risks
With so many potentially high-impact risks, it’s critical that companies develop a formal process for managing these risks. While there is not a single way to identify and monitor emerging risks, three key themes consistently materialize in successful risk management approaches. These themes include:
- Separating the emerging risks process. Emerging risks are fundamentally different from more short-term, operational risks and should therefore be treated differently. Leading companies recognize the need for a separate, more qualitative and creative process for identifying and managing emerging risks (often dedicating specific committees or teams).
- Relying on subject matter experts. Effective ERM teams often bring in individuals with a specialized understanding of particular external, macroeconomic trends to help create scenarios, assess the likely direction of trends and measure the potential magnitude of impact on the enterprise.
- Invest in robust scenario planning. Due to their longer-term nature, major external emerging risks require an effective scenario planning process to truly build confidence that their impact has been correctly assessed.